A new mandate for a new economic environment
“Central banks are creatures of history,” and their mandates have been adjusted over time argue Goodhart and Lastra in this paper. Since the Great Financial Crisis, a new model of central banking has emerged as central banks have been entrusted with multiple and broader objectives (price stability, financial stability, climate change), additional functions (macroprudential policy and crisis management, and acting as lender of last resort) as well as supervision powers. But this broadening of central bank agenda, warn Goodhart and Lastra, is more susceptible to politicization. In addition, as we have now entered a period of higher inflation due to a growing shortage of those of working age, while the ranks of the aged increase, the context for monetary policy has become much more difficult. Trying to restrain demand sufficiently to bring inflation back down to target, would inevitably weaken tax revenues and raise certain expenditures, such as unemployment benefits, thus worsening the primary deficit. At the same time, higher interest rates have the potential to increase the debt service burden. Goodhart and Lastra recommend:
[T]he central bank can no longer expect to successfully meet its mandate for price stability without the support of an appropriate degree of fiscal retrenchment. So our conclusion is that the prior degree of separation between monetary and fiscal policy can no longer be maintained. And we need to reconsider the institutional structure in order to enable an appropriate degree of coordination between the two arms of policy.
The Changing and Growing Roles of Independent Central Banks Now Do Require a Reconsideration of Their Mandate
Authors: Charles Goodhart, Rosa Lastra
From: LSE, Queen Mary University of London
The case for a narrow mandate
Demand for safe assets is distinct from demand for liquidity, argues Enrico Perotti in this paper. In particular:
- Safety demand appears quite inelastic, as savers accept minimal nominal rates provided capital preservation is assured over the medium term. In addition, safe asset demand appears to be closely related to total wealth. Therefore, when a central bank provides liquidity support for safe claims (as defined by regulation, thus encompassing public debt, deposits and demandable claims redeemable at par) it ensures stability of the financial architecture by avoiding disruptive runs.
- Liquidity demand can be satisfied by quasi-safe claims issued by shadow banks. When a central bank provides liquidity insurance to such claims it undermines stability as it encourages risk creation while confusing safety-seeking investors.
We make a case for a narrow mandate to maintain and safeguard the border between safe and quasi safe assets. This ex-ante definition minimizes ambiguity and discourages risk creation and limit panic runs, primarily by separating market demand for reliable liquidity from risk-intolerant, price-insensitive demand for a safe store of value. The central bank may be occasionally forced to intervene beyond the safe core but should not be bound by any such ex-ante mandate, unless directed to specific goals set by legislation with explicit fiscal support.
A Safe Core Mandate
Author: Enrico Perotti
From: University of Amsterdam