Following excerpts adapted from Tumultuous Times: Central Banking in an Era of Crisis by Masaaki Shirakawa published by Yale University Press. This is a rare insider’s account of the inner workings of the Japanese economy, and the Bank of Japan’s monetary policy, by a career central banker.
Independence and accountability are indispensable building blocks of the framework for governing central banks in democratic societies. This incentivizes the central bank to achieve the stability of the currency in the long term, but it does not necessarily guarantee the actual delivery of a good outcome. Ultimately, it depends on whether or not the central bank actually makes the right decisions. Of course, it is not realistic to expect the central bank to be an infallible institution; our goal should instead be to make it less susceptible to making wrong decisions. Like any other institution, the central bank is an organization composed of people and characterized by its own unique culture. There are many organizational issues that are worthy of serious consideration.
CENTRAL BANKERS AND MEDICAL DOCTORS
Alan Greenspan, the onetime chair of the Federal Reserve Board (FRB), was once described as a “maestro” . This metaphor, though quite famous, does not fit well with what I understand the central bank governor to be, because the word “maestro” unduly emphasizes the great talent and skill of a single individual. To state the obvious, the central bank is an organization, and it is not and should not be dominated by a single person, as the knowledge and ability of a single person is inherently limited. Furthermore, the economy is not something that can be orchestrated freely through monetary policy.
I have come across numerous metaphors describing the job of the central banker. One example is that of an airplane pilot.1 When confronted with sudden troubles in the sky, pilots in the cockpit quickly need to make the right decisions. The same applies to the central banker when private financial institutions become insolvent during a financial crisis or when the functioning of financial markets is disrupted by natural disasters or computer breakdowns.
But important differences exist between a pilot and the central bank governor. As for the decision by the pilot, the time allowed in the face of imminent danger is very short. There are usually no experts on the airplane other than the pilot and the copilot once it leaves the runway. As for decisions by central bankers, the time allowed is usually longer than seconds or minutes. Further, we can tap on the wisdom of experts outside the central bank. Many people—both experts and self-proclaimed experts—express their views, and some of them are quite vocal. In fact, I suspect differences of opinion among experts are much bigger as regards monetary policy. While passengers of an airplane do not have a choice other than to leave their destiny in the hand of the pilot, the general public does not give the central bank such carte blanche.
If I were pressed to give my favorite metaphor for describing the job of the central banker, without hesitation I would choose that of the central banker as medical doctor. As doctors take care of the health of people, central bankers take care of the health of the economy—both in terms of price stability and financial stability. The biggest similarity is that both jobs presuppose an enduring relationship of trust with the beneficiaries of the services in order to do the jobs properly. Patients go to their regular doctors, as they know that the doctors can be trusted through a long-standing relationship. When we need to have surgery, doctors explain the efficacies and possible side effects beforehand, and we give our consent as we are confident that they are making an accurate diagnosis and proposing the best treatment. The same is true for monetary policy. The public’s trust of the central bank is vitally important. What constitutes such trust is twofold: the central banker makes his or her best judgment as an expert and then implements the best policies based on this judgment. Another similarity between medical doctors and central bankers is that the level of knowledge when making recommendations is often limited; both the bodies of human beings and the working of the economy and financial system are that complex.
Though there are many similarities between central bankers and medical doctors, one important difference exists. While patients can choose a doctor from a group of doctors, the general public cannot choose its central banker. That is why the public governance mechanism of the central bank—independence and accountability—is put in place. Independence makes it possible for the central bank to take monetary policy measures that it judges to be the right ones. This is necessary but not sufficient. The central bank actually has to have the ability to make the right decisions. Otherwise, an independent central bank can cause a disaster.
THE LEGITIMACY OF CENTRAL BANK INDEPENDENCE
In a democratic society, what is the legitimacy of a group of unelected officials at the central bank conducting monetary policy? Of course, the central bank is entitled to independence by law. But this legalistic answer is not complete. Central bank independence can be stripped if the country’s politicians and ultimately its citizens wish to do away with it. Furthermore, legal independence is not the same as de facto independence. In fact, the Japanese inflation rate was lower in the 1980s than that in West Germany with an independent Deutsche Bundesbank, despite the fact that the Bank of Japan did not have legal independence.
The legal independence of the central bank is a manifestation of the fact that people at large, recognizing the importance of price stability and financial stability, are prepared to delegate the task of achieving those goals to the central bank. Just stipulating independence in the central bank law is not enough; societal support for that independence is fundamentally necessary.
But the public at large understandably does not bestow such societal support for the central bank without actually enjoying good macroeconomic performance. This is a “chicken or the egg” problem. In any event, the legitimacy of the independent central bank depends on the public having a sense of trust that the central bank is competent and faithful in achieving its mission. The central bank is, like any other institution, formed by people, characterized by its unique culture, and influenced by subtle group dynamics. This means that, on top of public governance of the central bank, we have to pay sufficient attention to it from an organizational or administrative perspective.