John Kay on Central Bank Credibility

Few, if any, newspaper columnists are as consistently insightful and challenging as John Kay of the Financial Times.  In his column today (“The dogma of ‘credibility’ now endangers stability”), Kay brilliantly demolishes the modern obsession with central-bank credibility, the notion that failing to meet an arbitrary inflation target will cause inflation expectations to become “unanchored,” thereby setting us on the road to hyper-inflation of Zimbabwean dimensions.  (Talk about a slippery slope!  If only central bankers and Austrians Business Cycle Theorists realized how much they had in common, they would become best friends.)

Here’s Kay:

The elevation of credibility into a central economic has turned a sensible point — that policy stability is good for both business and households — into a dogma that endangers economic stability.  The credibility the models describe is impossible in a democracy.  Worse, the attempt to achieve it threatens democracy.  Pasok, the established party of the Greek left, lost votes to the moderate Democratic Left and more extreme Syriza party because it committed to seeing austerity measures through.  Now the Democratic Left cannot commit to that package because it would lose to Syriza if it did.  The UK’s Liberal Democrats, by making such a deal, have suffered electoral disaster.  The more comprehensive the coalition supporting unpalatable policies, the more votes will go to extremists who reject them.

We got into this mess in 2008, because the FOMC, focused almost exclusively on rising oil and food prices that were driving up the CPI in the spring and summer of 2008, ignored signs of a badly weakening economy, fearing that rises in the CPI would cause inflation expectations to become “unanchored.”  The result was an effective tightening of monetary policy DURING a recession, which led to an unanchoring of inflation expectations all right, but in precisely the other direction!

Now, the ECB, having similarly focused on CPI inflation in Europe for the last two years, is in the process of causing inflation expectations to become unanchored in precisely the other direction.  Why is it that central bankers, like the Bourbons, seem to learn nothing and forget nothing?  Don’t they see that central bank credibility cannot be achieved by mindlessly following a single rule?  That sort of credibility is a will o the wisp.

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13 Responses to “John Kay on Central Bank Credibility”


  1. 1 Steve May 16, 2012 at 6:49 am

    But David, central bank credibility is quite useful!

    In Europe, the ECB has convinced people that it would see through a Euro breakup in order to keep a lid on prices. This has been quite useful in forcing through austerity measures!

    And in the US, the Fed has persuaded people not only that jobs are difficult to find today, but that jobs will always be difficult to find. This has produced a speedy decline in the unemployment rate as workers exit the workforce, a decline that might not have happened if the Fed had less employment fighting credibility.

  2. 2 Woj May 16, 2012 at 10:43 am

    What role do you think politics plays, if any, in the Fed and ECB decisions to focus on CPI/PCE inflation during periods where oil or food prices were seemingly experiencing temporary spikes?

    Those two categories are highly visible to most individuals who may mistake short-term price swings for significant inflation. ’08 was an election year and high oil prices are possibly a negative for the incumbent party. If there were a supply-side spike in oil this summer (due to Iran-Israel?), is it possible the same scenario plays out again?

  3. 3 Mike Sax May 16, 2012 at 2:02 pm

    David I certainly agree with you that trying to follow a single rule is mindless. However, don’t many of your Market Monetarist brethren make it sound the same-that we much choose a NGDP target and stay with it come hell or high water.

    What I notice is that some MMers call for a target of only 3% or so-by that criteria we are already overshooting and need to tighten

  4. 4 Marcus Nunes May 16, 2012 at 8:07 pm

    Mike Remember it´s a LEVEL target.

  5. 5 Julian Janssen May 16, 2012 at 10:10 pm

    Here’s my latest post on economics, “Labor Reallocation in a Depressed Economy”.

    http://socialmacro.blogspot.com/2012/05/labor-reallocation-in-depressed-economy.html

  6. 6 Mike Sax May 17, 2012 at 1:58 am

    I understand that Marcus but at this point what is the trend of NGDP since 2008? It seems like it’s probably at least in the ball park of 2.5 or 3. I mean I know we were way upside down in 2009, still…

  7. 7 David Glasner May 17, 2012 at 6:50 pm

    Steve, Gee, why didn’t I think of that?

    Woj, I do not know. The goal should be to have stable or slightly increasing money wages over time, not to focus on temporary movements in output prices. Hawtrey understood that.

    Mike, There is a danger is sticking to any rule no matter what the consequences. If an NGDP rule was working badly and I had a good explanation for why it was working badly then I would not stick to it either. But an NGDP rule is inherently more flexible than an inflation target and is therefore less likely to get you into trouble. The other point you are forgetting is that advocates of NGDP targeting are generally in favor of level targeting which under current circumstances would provide room for temporarily faster increases in NGDP than 5%. Even if the goal were to reduce the target over time, you wouldn’t want to move to a lower target until you had restored something like full employment.

    Marcus, Right.

    Mike, The point of NGDP targeting is not to keep us on our current path.

  8. 8 Tas von Gleichen May 18, 2012 at 3:50 am

    Central Bankers believe in the keynesianism model, and they won’t stop.


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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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