The comic strip presents ... central banking

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The Independent Online
We do not usually review comics in the business section of this newspaper, but a new one from an unusual US publisher deserves a break from tradition. It is a little 24-page booklet, in strip cartoon form; it comes from the Federal Reserve Bank of New York, no less; and it is called The Story of Monetary Policy.

Of course, the Japanese have for many years used the comic strip form to get across serious messages, and the Fed has been producing comic books since the 1950s. But this is its first effort at conveying the importance of something as abstruse as monetary policy. Previously it focused on issues such as the need for people to save or how banks worked. It is a giant leap from that to explaining the intricacies of M2 and open-market operations in a comic strip. This raises two important questions. Does it succeed? And is the exercise worth while anyway?

My answers would be yes, and yes - and not just because if people cannot explain something in simple language it usually means they have not understood it themselves. As far as the clarity of explanation is concerned, have a look at the page reproduced here. Explaining the need for open-market operations - the central bank buying and selling government securities to add or take away reserves in the banking system - is one of the toughest bits to get across. Judge for yourself, but the booklet seems to me to make a pretty good fist of it.

As for the need to do this exercise, quite aside from the need for central banks to explain why they are so focused on containing inflation and the damage this does to an economy, there is surely value in explaining the constitutional position. Indeed one of the most striking aspects of the booklet is the emphasis it puts on the mixture of independence and accountability of Federal Reserve Board members. They are independent of the Administration of the day, and the Fed chairman cannot be dismissed if there is a change of President. But at the same time, the chairman is required to explain the Fed's policy to Congress at least twice a year. The booklet acknowledges that the Fed governors and the President sometimes disagree, but it makes a virtue of the point that a President can normally appoint only two governors in his four-year term, thereby making it impossible to pack the board with political appointees.

Now, of course, the Federal Reserve system's constitution is not perfect, and in any case could not be replicated here because of the federal nature of the US. But the need to explain and to justify the role of an independent central bank could hardly be greater - and not just in Britain.

For perhaps the past 10 years the fashionable argument has been that central banks should be independent of governments. A requirement for that to be so is enshrined in the Maastricht treaty. Here in the UK, independence for the Bank of England is accepted by the Labour Party, so it may well happen after the next election. And though the present government has not gone that far, it has taken a number of the practical steps that would have to be taken were the Bank to become independent, such as the publication of the minutes of monetary meetings.

But as with all fashionable ideas, there is a danger of a backlash. Look at the evidence of recent weeks. Here we have had an increasingly clear difference of opinion between a Chancellor facing an election and a Bank fearful of a resurgence of inflation in a year or so - after the next election. But there has been no real upsurge of popular support for the Governor against the Chancellor. There is another meeting this week between them, and some people in the City expect another fall in base rates before the autumn is out. If that does happen, do not expect people to march in the streets saying that they want interest rates to remain high.

Over in France, the Banque de France, which has just been made independent, is being criticised by the government for being too timid on interest rates, and we may well see what is already a serious rift growing even wider through the autumn. There has been great tension between the Bank of Japan and successive governments there, even though the Bank of Japan has not been noted for strident independence. As for the European Monetary Institute, the embryonic European central bank that will administer the "euro", expect strident criticism should it ever replace the Bundesbank and the Banque de France as the main body formulating European monetary policy.

There are two rather different points here. One is the need for central banks to reach out to ordinary people - not just the sophisticates who deal in financial markets - and explain what they are doing, why it matters, and why the functions they carry out need to be distanced from politicians. It is much harder to maintain independence than it is to gain it. For while independence can be granted by government edict, justifying the unpopular decisions that will inevitably have to be taken from time to time requires central banks to build a constituency of support. In other words they need to do much more widely what the New York Fed is doing with its little booklet.

The other point is the need for accountability. There has to be a mechanism that the central bank can use to justify its actions, but there also has to be a mechanism for those who disagree to exert influence. However independent they are, our central banks have to work in a democracy - they have to operate with the tacit consent of the people affected by their actions. Passing a law saying the central bank is independent is not enough.

If you doubt that, consider what has been happening to another requirement in the Maastricht treaty, the need to get public-sector deficits down to 3 per cent of gross domestic product. There are powerful economic and ethical arguments not just for getting it to 3 per cent, but far below that. Given the demography of Europe, nations ought not to be running deficits at all; they ought to be running surpluses to help fund the next generation of pensioners, for to do otherwise is to steal money from the next generation of wage earners to improve the living standards of the present one. But in France and Germany, the case is not being made in economic or ethical terms. No, budget deficits have to be cut to comply with Maastricht. Understandably this is not particularly convincing.

There is surely a similar danger in monetary policy. There are powerful economic and ethical arguments for trying to ensure that prices are stable. And there is quite a lot of evidence that this is best achieved by giving central banks a large measure of independence. But advocates of independence have hardly begun to build a constituency of support; and the plans for the European Central Bank, modelled on the Bundesbank, suggest it will not be very strong in the accountability department.

That is why the NY Fed's little booklet is so useful. When we have finished sorting out the Bank of England's constitution to make it more accountable, we should get the Bank to do a similar exercise. I shall send my copy round to Eddie George forthwith.

q Copies of the 'The Story of Monetary Policy' are available from the Public Information Department, Federal Reserve Bank of New York, NY 10045; phone 001 212 720-6134.