Former Central Bankers on the Federal Reserve and Financial Stability

Former Central Bankers on the Federal Reserve and Financial Stability

More on:

United States


from Stephen C. Freidheim Symposium and Stephen C. Freidheim Symposium on Global Economics

Arminio Fraga, former president at the Central Bank of Brazil, Jacob A. Frenkel, former governor at the Bank of Israel, Philipp Hildebrand, former chairman at the Swiss National Bank, and CFR Distinguished Fellow and Former Bank of England Governor Mervyn King join Roger C. Altman, former deputy secretary at the U.S. Department of the Treasury, to discuss their experiences as central bankers and insights into past financial crises. The panel examines the evolution of central bank functions, political threats to central bank independence, transparency, and the undercapitalized banking system.

This meeting is part of the Stephen C. Freidheim Symposium on Global Economics: 100th Anniversary of the Federal Reserve System, made possible through the generous support of Stephen C. Freidheim.


ALTMAN: Good afternoon, everyone. Welcome to the third panel of the afternoon. And we're going to have the benefit, I think, of some really interesting reflections and observations by a very distinguished panel of former central bankers and very active participants today in the global financial system.

And if I—I think you all know who the panelists are, but if I can just say, Mervyn King to my far left, who of course is a very distinguished former governor of the Bank of England; Philipp Hildebrand to his immediate right, former governor of the Central Bank of Switzerland; Jacob Frenkel, former governor of the Bank of Israel; and Arminio Fraga, who's former governor of the Central Bank of Brazil.

I'm Roger Altman, and I have the privilege of moderating this. I'd just remind everybody of the ground rules. These comments are on the record. I would ask all of you, please, to keep your cellphones and PDAs off. And we'll have a period of discussion among us here, and then we'll open this up to questions and answers.

We have a little bit over an hour, so let me start. And I'm going to start with a question I'd like each of the panelists to comment on. And it's this. As one looks back over the long history of the Federal Reserve and juxtaposes that against today, we see today the Fed under the type of political pressure here in the United States both from the left and from the right, which I at least, over my active years, have not seen before.

From the left, in terms of the supervision and regulation responsibilities of the Federal Reserve, and we saw some of these tensions play out a little over a week ago in Bill Dudley's testimony before the Congress, and from the right, in terms of issues of accountability and the proposal which in some form or other is on the table of, quote, "auditing," unquote, the Federal Reserve.

And my question is — and I'd like to start with Mervyn and we'll just go from left to right — is whether as you watch these pressures you think of them as inherently transient or more worrisome than that, and whether they truly concern you from the point of view of the running room and independence of the Federal Reserve?

So, Mervyn, if we can start with you.

KING: Well, thank you, Roger. And good afternoon, everyone. It's a pleasure to be here and join you.

I am concerned. I think there's always a great temptation in thinking about any institution to assume that basically it doesn't change. But even central banks do. We're celebrating the centenary of the Federal Reserve. There wasn't one 101 years ago. There is today. Its remit has changed over time.

So it certainly can change and evolve. I have no doubt that it will. And I think Congress is perfectly capable of introducing either good or bad legislation.

The reason I think there is pressure now is that whereas in the context of monetary policy, around the world, central banks have evolved a very clear mandate and a system of accountability that was not challenged. When the crisis came, the actions that central banks were called upon to take to act as a lender of last resort were things for which there was not a very clear mandate. And in particular, the Federal Reserve pushed the envelope very hard, right up to the boundary of what could legitimately be said to be within its legal remit, and that was done in order to help protect the United States and its economy.

But it did open the door for people to say, well, what was the authority you had to carry out various actions? And that's put that — the nature of that authority under a pretty big spotlight.

Now, I think two things follow from this. One is, it is very important to have a clear mandate, what the central bank can do when it acts as lender of last resort in a crisis and, secondly — and this is the thing that worries me more — there is a very naive view about what transparency means. Transparency does not mean having television cameras in the room where deliberations are made. There has to be a room for private conversation. And I think that politicians on both sides of the Atlantic, simply because of their own immediate instincts, feel that anything that's said or written down should be exposed to the world at large.

If you do that, A, nothing will ever get written down, and that's happened on both sides of the Atlantic already. And, B, people will be very reluctant to say what they think in any meeting where they fear that the deliberations will not be private. And I think that is a very deep source of concern, and I worry about what it will do to the quality of decision-making.

ALTMAN: Philipp?

HILDEBRAND: Yes, I would perhaps add to it or complement — you know, like Mervyn said, we have to begin with the fact that this has been the deepest, most severe crisis, as we heard in the previous panel, in a very long time, and moreover, that the reactions, the response that central banks pretty much collectively came up with has been the most extreme in history.

And so, therefore, it shouldn't surprise us that sort of central banks continue to be very much in the spotlight and that perhaps it does feel more threatening than it would have felt in the past, even though my reading of history at least is that every time you have a crisis, central banks tend to be somewhat politicized.

Perhaps in — a final dimension to this is, of course, the more central banking becomes, let's say, overburdened, not just because of the severity of a crisis, but because of the inability or the unwillingness of the political system to do what is the responsibility of politics and sort of use the central banks to make up for that, the more this becomes a kind of self-fulfilling problem. And it seems to me this is certainly something we're seeing in Europe at the moment and probably to some extent here in the U.S.

So the worst situation is one where politics step back, the central bank has to continue to do more and more and more to deal with fundamental political problems, and as a result of that, becomes politicized in the process, and ultimately in the worst case it starts to undermine its sort of technocratic long-term function that is provided for by the mandate. And that's the dynamic that I'm concerned about, particularly when I look at the situation in Europe at the moment.

ALTMAN: Jacob?

FRENKEL: Well, you asked if it is a worrisome phenomenon. Very worrisome. Very worrisome, because the most important asset of a central bank is its capability to act independent of the political pressures because it is responsible to think about the medium term, and the political pressures are typically focusing on the short term.

Now, there are three reasons why it has been now more prominent than before. First, when you have a slowdown in the economy, let alone a recession, it's the breeding ground for looking around for how to intervene and how to interfere.

Second, when the most important element of economic policy is dysfunctional, in this particular case, I think there is an agreement that Washington is dysfunctional, or was, clearly, all the lights are put on the Fed.

Third, the Fed today, and in the last few years, has been more transparent than ever before, and if you remove the curtains and you have glass windows, people not only see what you have there, but also feel that they can participate in what you have there, and that's a little bit of a confusion.

Now, there is an analytical issue, without taking sides, but the central banking in the past few years have clearly expanded their scope and range of activities. And to some — and I am part of those — I believe that the measures were correct and appropriate and the expansion was, in general, right. But to some others, the argument would say, well, you stepped into a territory that has potential tax implications, potential aspects that really belong to Congress so don't be surprised that we come in.

And lastly, there is one dictum which is called the "pottery shop principle". When you go to a pottery shop, there is a sign, "If you break, you own." And basically, the Fed, seeing the vacuum in some of the other policy arena, stepped into it, and properly so, but before long, not always having the instruments at its disposal to do things in other areas, they are being held responsible for areas that in normal times would not be theirs. So that's a confusion that is also there, and I think that once the recession is over and once history is being written, not only rewritten, there will be a way to sort it out.

ALTMAN: Arminio?

FRAGA: On the politics and the threats to independence, I think for the most part everyone agrees that you want the Fed's running monetary policy independently, taking a long-term view, so, in a way, depoliticizing that. Where it's more complicated — and where I think the political pressure is here to stay — is where there are more visible distributive concerns, and that was clearly the case during the crisis and its aftermath, and I think the Fed did what it had to do.

But I don't think this is going away. So it may lead to rules where some of the decisions in extreme circumstances may have to be shared with the Treasury or something like that. Other countries may have reached this kind of solution.

I worry — also taking a long-term view — that central banks also have had a role to play in this overburdening. And I do agree that central banks are overburdened, and that's just what it is. But often, I see central banks sounding like they know more than they really do and, in a way, kind of being happy to play along, and it's very tempting to do that, but then they suffer.

And lastly, on communications, more importantly on transparency, I agree with what Stan said earlier, and Mervyn, and I've experienced this at the Central Bank of Brazil. I really — I really think it is important that there is room for frank discussion where people can say things, speculate about things, intellectually speaking, not being afraid of eternal criticism or embarrassment.

And actually at the time I was at the central bank, I used to talk to my colleagues about all these things, how their FOMCs were structured and so on, and I think at some point the Fed will have to re-address this, because I think the quality of the debate, the internal debate loses, and so the quality of the policymaking loses, as well.

ALTMAN: In the same spirit, in picking up on something you just said, as we look back on the crisis and think about that in the context of the entire history of the Federal Reserve, we saw something — I think — unique, which was if you look at late 2008, 2009, 2010, you see that virtually all of the support given to not just the financial system, the credit system, but also to the economy as a whole, was provided by the central bank in this country, and very little of it, given the scale that was necessary, took the form of fiscal stimulus or fiscal assistance.

And then if you say to yourself, well, the financial crises are going to occur — well, have been occurring with greater frequency or going to occur with even greater frequency, and periodically we're just going to have some bad ones, if, indeed, this pattern repeats itself and the entire burden or virtually the entire burden of rescue and support and stabilization falls on the central bank, is that ahistorical? And is that ultimately going to weaken the Federal Reserve? Or is it just, in one form or another, par for the course? And I'll go back to Mervyn.

KING: I don't think it's ahistorical. I think the real risk is exactly what Arminio said, which is that if people look to you for the answer, it is terribly tempting to say, yes, don't worry, we'll sort it out, we'll come up with the answer.

One of the things, when going to the Treasury Committee, that I often said to them was, "I don't know." And initially they sort of thought this was a weird answer. You know, what do you mean you don't know? It's your job to know. And I said, "Well, I don't have a crystal ball." "But, why not? It's your job to have a crystal ball."

And I think you've got to be willing to educate parliament and the electorate to the view there are many things that none of us know. And that doesn't mean to say that central banks are ineffective, but it means that they are not all-seeing and all-wise. And I think it's very important to get that point across.

ALTMAN: Philipp?

HILDEBRAND: I agree. I mean, the problem we're in at the moment, of course, is that fiscal space is also quite limited, right? So if you believe that by and large central banks are overburdened or certainly stretched in many ways, but by the same token, you realize that by and large in the Western world, not just in the Western world, we have a significant debt problem — the BIS has estimated I think that since the crisis, global debt-to-GDP has actually increased by 20 percent sovereign debt — that, of course, is a shocking number in a way when you think about it, and so that leaves you with relatively little fiscal room to sort of complement or to take some of the stress away from monetary policy.

Moreover, I think, you know, the world and politicians have recognized that central banks have been pretty good at fighting this crisis. And so given the limited amount of fiscal space and the recognition that there's an actor out there who can kind of do wonders, even if they don't know everything, it's quite tempting, of course, for the political side to step back and say, well, then let's just have the central bank deal with it.

And as we heard the previous panel take that to the extreme, and you end up with central banks getting more and more involved in what I will call quasi-fiscal measures, and that, of course, creates the kinds of political problems that you started with.

FRENKEL: Well, I think that the syndrome of being referred to as "you are the only game in town" is intoxicating, and it's a very dangerous one. When you go to the symphony and at the end everyone says, the violinist was the only one who played well, the violinist may be happy about it, but the conductor would commit suicide.

And there is an issue here. And in fact, I remember, I told Mario, when they call you Super Mario, you should worry, and for the same reason that the maestro should have worried. The central bank is very important, but only part of the policymaking body, and it will be a mistake to either convey the impression or even settle for the notion that "I can do it all, because I'm a good citizen", and you really create the wrong incentives at the end of the day.

FRAGA: One quick comment on this is, in a way, right, you're in a — you're a central banker and you're in a panic, you have to deal with it. The thing I miss sometimes, having been through situations like this in my own country and following the emerging markets more than the more mature markets, is that often you then go from crisis to crisis without realizing that they're connected, and this is not a one-off game. This is a repeated game. And you don't structure it in a way that, say, prevents this from happening in the future.

So a lot of this is endogenous, and it's fed by asymmetric monetary policy and other such issues, and if everyone thinks there's a super central bank out there, of course, they take more risk. And so I am somewhat uncomfortable still with kind of where we're heading with financial regulation in general. It's too complex. No one understands it. And the connections with that and monetary policy and all this, I think we're still a long way from something that seems right for the long term.

I think 2,000-page bills or 5,000-page bills, in my opinion, are not the solution. One day somebody will come up with a five to ten page bill that will do the job, and they will throw the big encyclopedia in the trash can, is my prediction for anyone who cares.

ALTMAN: You might not want to hold your breath on that one, as far as the U.S. Congress is concerned.

HILDEBRAND: Roger, if I can tell just a short anecdote...

ALTMAN: Please.

HILDEBRAND: ... when we introduced early on very severe capital requirements in our Swiss banks — severe from their perspective, which have now become international — they used to come into my office and give me hell about it. So I had this thing — I had the early draft of the U.S. legislation printed out, which depending how you printed it was about 1,000 pages, and our capital regime was basically fifteen pages. So I would stick, you know, both documents and say, which would you rather see?

And that usually killed the conversation. So I agree entirely with — we should have done much more capital and much less than everything else, is my conclusion today with some time to reflect back on it.

ALTMAN: OK, that segues nicely into my next question, which centers around the supervisory and regulatory responsibilities of the Federal Reserve, vis-a-vis this — the crisis and the aftermath. In its own way, the Fed has — at least I think — essentially admitted that it wasn't on top of its regulatory task in the run-up to the crisis, in effect, too permissive or behind the curve.

But at the same time, at least I think, the Fed has done quite a heroic job in restructuring, recapitalizing, and re-regulating the U.S. banking system and brought it to a point of considerable strength in just a few years.

And we all know that in certain countries, including advanced countries, the regulatory and supervisory function is not embedded in the central bank. So the question is, as you look at the history of the Federal Reserve system and you think about the recent crisis and the aftermath, does it suggest that the ideal model is to combine monetary policy and regulation supervision under one roof? Or not to do so? And why don't I start with you, Arminio?

FRAGA: Thank you. I'm strongly on the camp of keeping it inside the central bank. I think the central bank is the lender of last resort. And it will have to have that capability anyway. Might as well leave it there and keep it — keep the tensions manageable and keep the systemic risk concerns well housed where somebody can then be accountable and be incentivized to do it well.

ALTMAN: Jacob, what do you think?

FRENKEL: Well, maybe I'll start with an anecdote. I became governor in 1991, and inflation in Israel was very high. And the day that I was sworn in, I got a phone call from the president of the Bundesbank, Hans Tietmeyer, who told me, Jacob, let me give you strong advice. If you have any opportunity to change the portfolio of your responsibilities, take bank supervision out of it.

And — well, he had — the logic that he had was you will have to raise interest rates significantly, you don't need to worry about the health of the balance sheets of the banks. It's not under your responsibility, then you will carry out your job and somebody else will worry. There is a logic to it.

But fortunately, I did follow his advice. Not that I did not raise interest rates, but the fact of the matter is that for the reasons that were mentioned already, central banks, in the conduct of its monetary policy must really have current, ongoing information about each and every details in the system through which it operates. The banking system is the main mechanism through which monetary policy is becoming effective, and you'd better have the information about it.

And our people say, but good relationships can work and you will get the information. That's not the way it goes in bureaucracy. Responsibility and authority must go together, and as a central bank, if you have to worry about the financial system and about price stability, you better have the information about the details of the banks, so fortunately, at least in Israel, the bank supervision is within the central bank.

There are other issues that have developed since in the financial sector, and this was the rationale for the FSA in the beginning, et cetera. So there are other supervisors of the financial sector, whether it is insurance or other parts, or securities. They will need to have interaction and cooperation. But when it comes to banks, my answer is, yes, without ifs or buts.

ALTMAN: Philipp?

HILDEBRAND: I think it probably depends. I would say there's no perfect model. Where we would probably all agree on is that the sort of systemic piece of the system and the regulatory dimension of the systemic part of the financial system, there it's clear to me that the central bank has to play a dominant role.

I would also say that in times of crisis, when credibility is key, the central bank can play a very important role. I think what's happened in Europe right now with banking union is going to prove to be deeply transformative. I think it's a much bigger deal than perhaps the world has realized. You know, that would have never happened had it been left to the supervisors to organize themselves. And even if it had happened, it would have never enjoyed the credibility it now has to be transformative.

Does that mean it should forever stay the ECB? Not necessarily. I think it's a very good idea that they're in separate buildings and are set up in a way that perhaps down the road they could become two distinct institutions. But at the moment, that would have never worked, had you given that task to some confederation of European regulators.


KING: I think the answer depends critically on the definition of regulation. If it's prudential regulation of banks, then I go along with Jacob's view. Where it isn't, then I think it's probably quite important to separate it out.

As Philipp says, there may be no ideal model here. So when the Bank of England was being re-designed in the 1990s, Hans Tietmeyer also rang us up and gave us the same advice.


FRENKEL: He never wanted to be by himself.

KING: The interesting thing, of course, was that a bit later, a few years later, when the Bundesbank lost monetary policy, they leapt into banking supervision with an enthusiasm that was difficult to imagine, given their previous position.

When we were given independence in monetary policy, the deal was that we would not be involved in banking supervision, and that was done explicitly as part of a political agreement that if the central bank was to be much more powerful than before, then it couldn't retain the powers over banking supervision.

I think I understood that argument. And the argument that we heard then from the Fed was actually monetary policy is more effective with all the information that comes from supervising banks. I didn't find that argument compelling.

What is much more compelling is the role of a central bank when there is a crisis. So when the crisis hit us, we had a major problem, because we were not doing prudential supervision. We did not have information about the liquidity position of the banks, which proved very difficult in the context of acting as a lender of last resort, and the regulator could not provide them to us. The data we wanted just weren't there.

And, secondly, within a matter of a few months, it was clear that it was an issue of solvency, too. Capital was required. But you can't evaluate the capital needs of a bank without being closely involved in supervising its balance sheet.

So although the legal position was that the Financial Services Authority was regulating the banking sector, once the crisis hit, the de facto supervisor of banks for prudential purposes pretty much started to switch from the FSA to the bank. That was not an easy position to find oneself in.

But I think in a crisis, the central bank just has to be involved. There's no way around it. What the central bank I think will be ill advised to get involved in is anything to do with consumer protection or conduct of business or the sorts of issues that you think of as the more legal-oriented aspects.

Where it concerns liquidity and capital of the banking system, I think that it's not a question of needing to have the information day by day to do monetary policy. It is a question of having the information available so that if and when a crisis hits — and as you said, they seem to keep coming — then you can't say, oh, we're going to get a crisis in six months' time so let's gear up our effort in terms of monitoring the banks. You need to be on top of it whenever that comes.

ALTMAN: Let me ask you a question about the parallels or lack of them between the ECB, how it's evolved and how it may evolve, and the history of the Federal Reserve in the following sense. As you think about the ECB, how applicable do you think the lessons of the Federal Reserve's evolution to where it stands today, how applicable do you think those lessons are to the ECB, as you think about how it may evolve? Or do the differences between the federalist nature of the United States and the confederation nature of Europe mean that those parallels are not particularly applicable?

Jacob, I'll start with you. I'm tempted to say, if you were chief of the ECB, what lessons would you draw from the Fed, but I don't want to put you out on thin ice, because this is on the record.

FRENKEL: Because the next one you will say, and if you are the chief of the Fed, and (inaudible) is my best friend, how can I do that?


What are the parallels? Well, it's very easy to come and say they are so different from each other and, therefore, A, B, C, D. And, indeed, they are hugely different. And they emanate from different political setting and all of that.

But I would like to put it the other way around of saying, what are the commonality? Because from all of those differences, there are some general principles of central banking that apply to the Fed, to the ECB, to the moon, or to anywhere else that there are central banks, and which is, primarily you really need to — your instrument of policy and your intermediate target are always nominal magnitudes. You may have in mind that you want to impact eventually the real growth of the economy and things of that type, but the mechanism by which you do it is through nominal magnitude, that if it is through nominal magnitude, the stability of the nominal system is essential.

And, hence, the — when it comes to bank supervision or when it comes to lender of last resort and when it comes to monetary targeting or inflation targeting or whatever, those are the first elements.

Second, you really need to be independent of the political system. Even though the political systems are so different in the U.S. and in Europe, it will be a disaster to either and, therefore, both, if they were not independent of the political system. When it comes to independence, there is nothing that created more confusion than that concept, because the man in the street says, what do you mean independent? You are not an elected official. Who are you to — we chose Congress. And they are right.

So there is to understand, the objectives are set by the elected officials, but when we talk about independence, we talk about independence in using the instruments that were given to us to implement the objectives that were given to us, but once they are given to us, we need to implement them in an independent, professional way. So those are common.

Now, you say, but that's all? You have done this, you have done 60 percent of central banking. And let me leave my other friends the other 40 percent.

ALTMAN: All right. Philipp, go ahead.

HILDEBRAND: I would say there — you know, I would point to sort of simplicity, two big differences in my mind. One, of course, is that the Eurozone is a very different construct from the United States of America. Our dear friend who passed away far too early, Tommaso Padoa-Schioppa, defined — shortly before he died, he defined the Eurozone as an intermediate state between unity and disunity, which I think is a wonderful definition. And he then goes on in this remarkable article that...


ALTMAN: You could apply that to my household.

HILDEBRAND: It's either going to go deeper towards integration or it's going to ultimately disintegrate back to something — what it was much earlier, which is an also very insightful, I think, observation. And, of course, at one point in the history of the United States, you had a very similar story, with also fairly intense debate, from my understanding, around the central bank.

But it's a very different situation today. And that makes — I think that makes the role or the job for the ECB as a single entity of this intermediate state between unity and disunity, in many ways, a much more challenging and a very difficult task.

The second important difference with regard to many other central banks — in some ways, most central banks — is that the Maastricht Treaty, in a very important article, explicitly says that monetary financing is illegal. So it has this — very few central banks have this explicit rule, which, again, curtails or certainly makes the operations for the ECB much more difficult in many ways than would be the case for the Fed or other central banks.

So I think, you know, we can go on — and there are many other subtle differences, because these in my mind are the two big ones that explain much of what we're seeing as the story unfolds at the moment, in terms of different reactions and different policies.

ALTMAN: Please, Mervyn?

KING: I find that on this side of the Atlantic, there is a slightly romantic notion about what Europe is, and that somehow all that the euro area needs is a reincarnation of Alexander Hamilton and all will be well. Now, what he did was quite remarkable. But creating a fiscal union out of a small number of primarily agricultural states which had already committed to a deep process of political integration and thinking through what the Constitution should look like is utterly different from a set of sovereign states with centuries of independent history, much of which spent fighting each other, many with empires around the world, and speaking different languages.

And there is an element I fear in the view on this side of the Atlantic that it reminds me of the old joke about the economist, the physicist, and the chemist on a desert island, where a can of food is washed ashore. The physicist and chemist come up with plausible mechanisms by which to get the can lid of and at the food, and the economist blithely says, "Assume we have a can opener."

And I think that too many people are saying, "assume Europe is one country." Europe isn't one country, which is why we all love to go around Europe on holiday and exchange our — you know, people going to live in different countries. It's the differences between them that makes Europe what it is.

And I think that it's been, in many ways, rather irresponsible to rush to a project, the success of which does depend on a high degree of political integration. The view in Germany in 1999 before monetary union went ahead had always been — and this is still the view, actually, held by many monetary economists in Germany — that monetary union should be the crowning glory of a long period of political integration. But as you don't rush political integration, you can't create one country out of twenty-eight different countries just like that. But if you want to go down that road, you take your time, and at the end of the process, monetary union will be the crowning glory.

Tommaso Padoa-Schioppa had a different vision. He wanted to do it the other way around, create the monetary union first in order to create a crescive, because he believed that only in a crisis would you get the appropriate degree of political integration. And I think we're about to see the real limitations on that. It's a gamble with what's going, and you can see with rising unemployment in Europe in the latest numbers published in the last week that it's a gamble that is still a long way from being resolved.

ALTMAN: Arminio?

FRAGA: I don't have anything to add to what Mervyn said. I was going to mention Alexander Hamilton, as well. And I'm pretty much in his camp. I've heard him more than once about this, I must say, so I was hoping I'd speak before him.


Back to you.

ALTMAN: If I was feeling my age even a little more, I'd say, well, I knew Alexander Hamilton, he was a friend of mine.


Let me ask one final question before we open it up to the audience, and that's a question about the Federal Reserve's dual mandate, both price stability and full employment. Certain other major central banks do not operate under as explicit a two-part mandate as the Federal Reserve system does. And if you think about the unconventional monetary policy, which the Federal Reserve has pursued over the past three years, for example, obviously, the full employment mandate is a big driver in that.

And the question is whether that dual mandate is a model, represents a model which would fit in most other or all other central banks and advanced countries or not, as you see it. Because it's not common. And let me go back to Mervyn.

KING: I don't myself think this is a major issue. I think the precise wording of the mandate is bound to reflect the political circumstances in which that mandate has been created. But I think if you look at the way in which central banks set monetary policy, whether they have an explicit inflation target, whether it's a general remit for price stability, or whether it's the Federal Reserve's dual mandate, in all cases, they try to achieve price stability, 2 percent inflation target in the long run, but recognizing that when there are deviations of output from what looks like a sustainable long-run position, there is scope to try and stimulate the economy or to slow it down.

What has never been resolved — and I think it's quite hard to do — is whether the mandate given to the central bank should actually specify how much weight should be given to deviations of unemployment from some long-run level or inflation from some long-run level. But in all cases, it is absolutely vital for the central bank to be completely committed to the long-run inflation target, because as soon as the market or other people start to believe that the tradeoff between output and inflation is not a short-run one, but is something which the central bank may take risks with in terms of its commitment to long-run price stability, then its credibility will go, inflation expectations and interest rates will rise.

HILDEBRAND: So long before I became a central banker, I once attended a seminar that Arminio and a common friend taught at Columbia University. And I remember they taught the students that if you want to understand a central bank's mandate, you have to look at its history, which is, I think, the point Mervyn just made.

I suspect, you know, there's been enormous amount of convergence. I come from an institution which has a — like the Bundesbank or the ECB — a sort of uniquely price-stability-oriented mandate, and yet I would imagine that our discussions in the governing board would have been no different in terms of allocation of time on price stability, on output, unemployment, than a discussion at the Fed, where you have a dual or maybe even triple mandate.

So I think in reality I would agree with Mervyn that there's been an enormous amount of convergence, which by the way you also see in the definition of price stability, which has now really converged, if you look with the latest changes. Japan, the Federal Reserve, of course, having gone to an inflation target, the same in Switzerland, the same in the U.K. Basically, everybody has now converged around the definition of price stability at 2 percent or very close to 2 percent.

So I think in practice, in terms of how the central bank works, it probably doesn't make a very big difference. The politics around it, of course — and I alluded to this earlier, with regard to the ECB — can be impacted by different mandates.

ALTMAN: Jacob?

FRENKEL: Well, to begin with, the concept of the so-called dual mandate in the U.S. is a relatively young phenomenon. It was sometime in the '70s that it was put forward, so — now we take it for granted that that's an issue. The Fed has worked for the largest part of its history without that dual mandate.

Second, words matter in terms of the language of the objectives, but circumstances also really matter. When my job as governor during the decade of the '90s, and as was Arminio's job in Brazil, we were in economies that came with legacy of hyperinflation. Inflation was high. Our job was to reduce inflation and to achieve price stability.

Now, obviously, the focus was on inflation. And a martian coming down to earth not knowing what our central bank law says, but trying to interpret from what we focused on would say, "They focused on inflation." So when I asked Alan Greenspan to explain to me, how can he find the equilibrium in the maze of the dual mandate? And when I asked Paul Volcker the same question, they gave me very interesting answer.

Paul told me — challenged me, find one speech that I ever gave that includes the words dual mandate. I never — it's not that I disrespected the law, but I thought I understood my job to be whatever it was.


Then come to Alan Greenspan, and you say, how do you reconcile the dual mandate? Because the question of weights come in. And the answer was, I interpreted it as the best way that we can achieve the growth part of our mandate is by providing the environment of price stability and, hence, I focus on price stability, because that's what I can do.

All right. So you don't need — so I ask him, if that's the case, why don't you change the law and make it more concrete? And his answer was, when you go to Congress, you know what you bring in. You don't know what you get out.

In that context, in Israel, we had at that time an old law that was like in the U.S. motherhood and apple pie. And the question was, how do we really transform it into something which is more consistent with what we are actually trying to achieve? And at that time, it was price stability or price stability and financial stability, depending when, and it took three governors to bring to completion of that legislation, and Stan was fortunate to be at the final point, but the fact is that it was very, very political.

And I remember one day — another small anecdote — that Prime Minister Rabin came to me and said, your esoteric view that you need price stability, where do we put unemployment? Where do we put growth? I want a law that will be encompassing what is really relevant for me as a prime minister.

And I said, you know what, why don't you — when you — next time you go to the U.S., meet with Alan Greenspan, talk to him a little bit. And he came back to Israel and he said, you know what, Jacob, I spoke to Greenspan. All of you governors speak the same language.


And it's an important point, because there is a convergence of views. While there are inflationary countries, price maintenance countries, at the end of the day, the principles are there.

ALTMAN: Arminio?

FRAGA: So before we throw the mic your way, I — my experience is as follows. Every time this notion appears in the debate back home — and we have inflation targeting, and we're not really sticking to it these days — it comes with a bias, and the bias is the central bank is too hawkish and we need to do something about that. But that, of course, is a country that's had hyperinflation. Inflation is still at over 6 percent and all that.

I see the point. I don't see why at this point anyone would change something that is working here. But I do find it slightly confusing, and it leads to this sort of interpretation. And I think each country has to deal with it. I don't have any magic solution. But I find it easy to sell the notion that Greenspan put forth. And moreover, because no one knows for sure what unemployment rate to target, you see it right now here in the states, where it seemed for a while 7 percent meant something, and then 6 percent, and now we don't really know, that it's kind of safer to try to convince people that having low and stable inflation is a good thing, that the central bank will try to smooth fluctuations in economic activity and kind of leave it at that.

But, you know, you can't rewrite history. And this country has done very well. So I wouldn't touch it, either. By the way, I actually think the 2 percent is interesting, that there's been this huge convergence. Neither Volcker nor Greenspan liked the notion of having a number, a fixed number. But you can leave that for a future discussion perhaps with the two of them.

FRENKEL: But there should — one more point? There should not be a confusion of saying that because at the end of the day it's all the same, that the wording of the central bank legislation do not matter. The wording matters very, very much. And I remember very well, when you were governor, Arminio, you invited me to meet with President Cardoso, and you came — you and Minister Malan, Pedro Malan, to Cardoso, and you asked me to convince him why central bank independence is important. And you did not have independence at the time. I failed completely.

FRAGA: We still don't.

FRENKEL: And I failed completely. And the reason — what happened was, he disarmed you completely. As we came into the room, he said, Arminio, look, you have Pedro Malan, such a good minister. You have Henrique Cardoso, such a good president. Is there any danger for independence? Why do we need to go through congress? Well, then came Lula.


ALTMAN: All right. Let's please have some questions. And please, if I might say so, please get to your question right away. So — yes, sir?

QUESTION: Thank you very much for the panel. Andrew Huszar, Rutgers. There are those who suggest that a new era of competitive devaluations is occurring now with — via unconventional monetary policy. I'm wondering if you worry about that, you know, for example, Japan and the yen falling, and whether you worry about devaluations and whether you worry about the ability of central banks to be able to coordinate policy effectively in the future.

ALTMAN: Phil, do you want to take that question?

HILDEBRAND: I was wondering whether he was looking at me. Look, I would say we talked about mandates just a minute ago. The fact is in a number of countries, as was mentioned earlier, the central banks are failing in achieving their mandate. And as we also know, it's hard to become more expansionary when you're at the zero lower bound. It's hard to become more expansionary in the case of my own institution, former institution, when you have no domestic bond market, for instance. So we couldn't do what Mervyn did or what the Federal Reserve did by simply buying bonds, because there are no bonds in Switzerland to buy.

So then you have to look at other things. And, you know, one of the consequences can be and has been, both in our case, as well as in Mervyn's case, that you have currencies that move. I don't think that should be seen as any form of competitive devaluation.

Now, where will we go in the future? We'll see. Obviously, the more difficult it becomes to meet these mandates, the more challenging the past becomes for — for central banks. But I think what I've seen so far, at least, in my own reading, talking about the major central banks, is, you know, very legitimate attempts in all cases to try to meet the mandate of price stability, which at the moment, in a number of cases, notably in Europe, is not being met.

ALTMAN: Yes, sir?

QUESTION: Niso Abuaf, Pace University. In a world where the Western world or the industrialized countries have the net present value of their assets being lower than the net present value of their liabilities, why would you want to stick to a 2 percent inflation target?

ALTMAN: Well, Mervyn?

KING: Well, because what matters is the real rate of interest, not so much the nominal one. And I think it's vital for central banks to retain control and belief in markets that we will maintain price stability. At present, obviously, inflation is below the target in most of the countries.

But I don't think the idea that one can inflate one's way out of this is actually terribly compelling, even if you decided you wanted to do it, and to hell with the long-run consequences, because markets are now much more alert than they were at the end of the Second World War. And with many countries, mine excepted, having a duration of government debt, which is relatively short, then actually the refinancing risk is very great. And as soon as you embark on a strategy of higher inflation, interest rates go up, and you'll be paying a higher real rate on the debt that you issue from now on, even if a large part of that is actually something to refinance existing debt.

So I don't myself think that inflation is — it may come, but I don't think it's a strategy that is going to reduce the indebtedness of governments around the Western world. I think the real problems facing the Western economies are genuine, and they're not ones which central banks can easily solve. And I think the biggest risk to central banks is actually that they will be expected to maintain demand at a level which monetary policy on its own is not sufficient or capable of doing. It's a necessary part of a strategy, but it isn't a complete one.

ALTMAN: Yes, sir?

QUESTION: (OFF-MIKE) NYU Stern. Tim Geithner's book brings out very strongly that he pushed the credible stress tests by the central banks and felt that that was quite useful in resolving the bank crisis in the U.S. Since then, it's been done in the European Union. Is this going to be a principal tool for central banks to get the right levels of capital into their banks in the future?

ALTMAN: Arminio?

FRAGA: Yes, I think, in general, in a crisis situation, when things seem out of control, you're looking for like a landing strip, like you're flying in a storm. And there have been other circumstances in countries in crisis where similar approaches have been done. Balance of payments financing used to be the classic situation where, say, there's a run against the currency and you're trying to stabilize things. Even after you let it float, things may be running out of control.

And I think the exercise was always to try to have enough in place between better policies and maybe some support for — to put a question mark in the minds of whoever is running. And similarly, I think in the case of financial sectors, particularly in a crisis such as the one we're hopefully just getting out of, there was this paralyzing fear that, you know, there would be a deeper collapse, like the Great Depression, and eliminating this doubt was very important.

And at the moment, unfortunately, it doesn't seem like Europe is fully benefiting from this, because there is this perception that the exercise in Europe was not rigorous enough. But I think it's a very good tool. If you can put together scenarios that work — and this is a classic for crises of all sorts — and once you have that there, then, you know, it's only a matter of time before things tend to calm down. And I do think this is — this is a very useful tool.

ALTMAN: Yes, sir?

QUESTION: Yes, please pick one. What do you think is a harder job, head of the Central Bank of Japan or Europe?


ALTMAN: Jacob, you...

FRAGA: You just want us each to pick one?

QUESTION: On the record, too.

FRENKEL: Thank you, Bill, for reminding me. I was about to say something that I would have regretted.


He always has been a good mentor. ...Both are fun.


You know, somebody said that the various crises are like London buses. And Mervyn will testify to it. You stand in the bus station and wait for the bus, and they don't come. And eventually, a bus comes, but three come together. And then you go on one of them, and it goes to the place that you don't want them to go. And I think that both Mario and Kuroda probably feel similar feelings in this way, so I'm not sure to who — which one is easier.

ALTMAN: Yes, sir?

QUESTION: Hi, John Macon, American Enterprise Institute. I split my time between New York and Washington, always a fascinating arbitrage activity. And I heard your concerns about central bank independence and Fed independence, and I want to test out something on each of you. You know, when there's a new Congress, there's always a flurry of talk about Fed independence. You know, we'll show these guys what they're going to do and so on.

I'm not too concerned about that, if the Fed does two things. One, on a very pragmatic basis, they get themselves a very good liaison to deal with congressional committees, like lobbyists do. They're not above that, and they should do that.

But, secondly, they give them something. And the framework that has been laid out here is that the Fed deals with monetary policy. I think they retain that responsibility. But on the regulatory side, they retain prudential responsibilities, but they give away freely the rest — consumer regulation and so on and so forth — to appease the forces both on the right and the left that want to constrain their independence.

But I may be naive. You've both dealt with legislators before. Is this — is this a bad strategy? Or is it something they should think about doing?

KING: Appeasement of legislators is not a concept that I find terribly compelling. I mean, whatever you give them, they'll demand a lot more. So I think you just have to go out and win the argument. There's a lot of contact, I'm sure, between the Federal Reserve and legislators in Congress, sort of informal contacts, and a very large number of formal appearances.

And I think that the most effective form of accountability — I've always said this to our own parliament — the most effective form of accountability is that we come, we explain in public what decisions we've taken and why, and you grill us on it. What more could you conceivably want? There is a public debate where anyone can enter that debate and say what they think, say whether the Fed is right or wrong. The information is there for people to judge. That is the proper form of accountability.

Now, politicians always want to make a splash on something or other. Look, they'll always have some particular game they want to play or extra piece of legislation or extra provision of transparency they want to have. But I don't see any reason to think that the Fed has to appease all that. The Fed just needs to make the arguments, and it is doing that. And it keeps going to Congress frightfully often. You only have to open the papers every few days, and there's somebody from the Fed who's making an appearance in Congress in one form or another.

ALTMAN: Byron?

QUESTION: This is a question for Arminio. Your country, Brazil, is facing an economic challenge. And some of it — some of us think that the policies that have been implemented by the administration up until now have created the economic problems the country faces. What would you recommend in terms of monetary policy that could be changed in Brazil that would put it back on a growth path?

FRAGA: I'm detoxing from what was a tough campaign. I put forth my views during the campaign. It would take me too long to go over that, so we'll leave it for another occasion.

ALTMAN: Yes, ma'am?

QUESTION: Hi, thank you. Cathy Taylor from The Policy People. I'd love to hear your views going back to Roger's comments about enforcement and supervision on the Fed's role among its three or four other peers in the U.S. at least on levying operational fines on banks for their operational activities. Obviously, post-crisis, these fines have been increased in both frequency and severity, and I'm wondering how you think the role — the process and the enforcement structure is set up for success.

ALTMAN: Is the question whether the Fed's powers allow for sufficient punitive treatment in these cases? Or is your question whether the Fed is doing the right thing?

QUESTION: Both. Or whichever you prefer to have time for in the interest of time. I know we only have a couple minutes. I'm curious if you think that this process thus far is an effective process, and are there changes or other models in other places that you would look to, to make it more effective? Hopefully it slows down, but if it continues at the pace it's been, it's probably going to be pretty onerous, not only on the Fed and its peers, but on the — continued beyond the banks.

ALTMAN: Philipp?

KING: Well, in America I've learned that everything is bigger — the buildings, the people, and the fines on banks.


HILDEBRAND: Well, I would just say that, you know, most of us probably are stunned by some of the bad behavior that's emerged sort of — or most of us — hopefully all of us — are stunned by the bad behavior that has emerged. I consider myself fairly realistic about market participants and what happens in the financial system. I was myself a market participant before I became a central banker. But I really am stunned, whether it's in London or in my own country or here, to see and hear some of the things that have happened.

So the question to me is more than sort of wondering about, how do we get out of this? I mean, clearly, that's not going to be conducive to growth if every other week you have a massive fine and so forth, but that's almost a secondary question, that the sort of — the principal question is, how could we have let business models create that kind of behavior? And how do we make sure that the business models of these financial institutions change fundamentally so that that type of behavior at least doesn't become sort of run of the mill?

And, you know, my own answer to that question early on — and has only become stronger, really, since over the last couple of years — is that the fundamental problem — this goes back to the earlier discussion — is we have had a massively undercapitalized banking system which has set completely the wrong incentives and has triggered all kinds of behavior that has ultimately sort of morphed into some of these horrible things that we've all been witness to.

So can we fight this with imprisonments and fines and so forth? I'm sure that's part of it. But it seems to me that ultimately the answer has to be — set the right incentives so that the business models fundamentally change and make this type of behavior less likely or at least something that shareholders in the long term simply will not tolerate, because the cost of capital will be too high.

FRAGA: I agree with that.

FRENKEL: You know, fundamentally, I think that there is a complete consensus that a system that has more capital, more liquidity, less leverage is a more robust system than the opposite. And that's really the key issue. And then comes questions about incentives and all the rest, which are very well understood and known.

But we need also to be aware that — and that's on both sides of the Atlantic — there are a lot of populist sentiments that do not recognize the importance of a well-functioning financial system. It's people — the man in the street does not really fully recognize what's the meaning of oil on the wheels.

So it is part of the leadership that must make sure that people understand that this is a very extremely important thing and, during a recession, there is nothing more tempting than to say this is the villain and now we know why you are unemployed. That's a very dangerous overshooting.

But having said all of that, let's not forget the basics. The basics is more capital, more liquidity, less leverage, and proper behavior.

ALTMAN: One more question? Yes, sir.

QUESTION: Hi, Joe Kronsberg, Cyrus Capital. Given the potential end to the commodity super-cycle and sort of what that's caused in terms of volatility towards the down — to the downside on commodities, how does that impact the monetary tools that the central banks have, I guess particularly those that are export-driven commodities, but also — or export-driven economies, but also those that are import-driven, as well?

ALTMAN: Arminio, do you want to take that?

FRAGA: If you have — if you're exposed to that and you have a fixed exchange rate, watch out. You know, I think here what the key tool is to have the exchange rate flexibility and hopefully also to — if you're, say, a country like Chile or some — or some of the oil-producing countries, to have some sort of long-term planning, some sort of fund where you can at least smooth some of these fluctuations, I don't see any way around it. And it's more the exchange rate than, say, interest rates as a tool. If you have that, then you do the best you can. But it is an issue. The standard tools apply. Just the problem is more complicated, I think.

ALTMAN: Well, I'd like to thank our panelists for participating today and making the time to do this. I'd also like to thank Steve Freidheim for his generosity in making this symposium today possible. Thank you, Steve. And thanks to all of you today for participating. We're adjourned.


Explore More on CFR


The Atlantic's Julia Ioffe joins CFR's James M. Lindsay to discuss Russian president Vladimir Putin's political goals.


In addition to a sharp economic downturn, Venezuela faces a humanitarian crisis. The United States can do little to prevent a downward spiral, but it should take measures to mitigate the political, economic, and humanitarian consequences of a potential mass emigration.

North Korea

The U.S. military is prepared for a number of contingencies with regard to North Korea, but the best path forward is diplomacy aimed at denuclearization.