As the world’s central bankers eye the European Central Bank’s decision to formally entrench carbon reduction into its monetary policy objectives, they should take a few minutes to remember the Tinbergen Rule.
The rule stems from the work in the 1950s of Nobel Prize-winning Dutch economist Jan Tinbergen, one of the fathers of econometrics – the field of statistical modelling and data-based policy-making that are the bread and butter of modern central banking. Mr. Tinbergen argued that for every economic policy target you wish to achieve, you need a separate, independent policy instrument aimed at that target. There’s no killing two (or three, or four) birds with one stone.
The value of that thinking has been proven over the past three decades of monetary policy, as central banks narrowed their focus to a single task: achieving low and stable inflation. The era of inflation targeting has been perhaps the most successful in monetary policy history, in no small part because it reduced policy to one transparent, measurable and (largely) achievable objective, one for which the instrument (interest rates) was well-suited. The result has been reliably low inflation and interest rates for decades, a widespread stability that has anchored the global economy.
But today, central banks – in Europe, Canada and elsewhere – are sensitive to the criticism that their narrow policy focus has left too many elements of the economy poorly served. The manipulation of interest rates in pursuit of 2-per-cent inflation, the critics charge, has created asset bubbles, contributed to income inequality, fed excessive debt burdens, neglected job creation, and overlooked climate change. Central banks are under pressure, from without and within, to respond, to take a broader definition of their vital role in fostering economic well-being – lest their role cease to be viewed by the general public as vital or relevant at all.
The ECB last week joined the Bank of England in formally entrenching climate change in its policy objectives, in addition to price stability. U.S. Federal Reserve Chairman Jerome Powell has increasingly framed the Fed’s full-employment goals in terms of addressing inequalities in the labour market. The Bank of Canada, which is in the midst of its own major review of its policy mandate, has been taking a hard look at its role in both these issues, while feeling the heat from Canadians who blame the bank’s interest rate policy for fuelling increasingly unaffordable housing markets.
Are the criticisms of the unintended collateral damage from a narrow inflation-targeting regime justified? Perhaps. But central banks have a decidedly limited tool kit to pursue their policy objectives as it is. You’ve got interest rates and, as an emergency measure, you’ve got asset purchases. That’s about it. If central banks try to tackle too many tasks with their limited set of policy tools, they risk compromising all of them – including their crucial job of inflation management.
This is, essentially, the position that the Bank of Canada has long taken on the role of interest rates in household debt and the housing market. It has argued that rates are a blunt instrument designed to have a broad influence over the economy as a whole, are ill-suited to fine-tuning excesses in regional mortgage markets, and to attempt to do so would detract from achieving the bank’s prime objective.
To some observers, this has looked like a shirking of responsibility, a passing of the buck. It’s not. It’s a practical understanding of what monetary policy can and cannot do.
University of Western Ontario economist David Laidler, one of the pioneers of inflation targeting, wonders if a lot of what we’re hearing today is anything more than “virtuous chatter on the part of institutions that are uncomfortable with the recently acquired visibility of their policies, and the political attention that this has generated.”
Even so, he worries that even talk of this kind of mandate drift risks watering down not only policy effectiveness, but also, just as crucially, central banks’ political independence.
Part of the beauty of the Bank of Canada’s 30-year-old inflation-targeting agreement with the federal government is that it has allowed the bank to stick to its own narrow policy knitting free of political interference, while sequestering it from other policy issues that were better left to the government’s fiscal and regulatory levers. Venturing into politically charged policy areas crosses a line that central banks might not want crossed.
“Getting the Bank of Canada’s conduct of inflation control policy out of day-to-day politics was not easy, and it has paid off massively. Current chatter about other goals, even if it is just virtue signalling, is drawing them back into that arena, and once established there, they won’t be able to keep inflation control tactics out of the discussion,” Mr. Laidler said.
“This is a serious threat, over and above the technical one posed by the possibility of aiming at multiple goals and missing them all. And all it takes to make it one is talk.”
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