43 W. Lee Hoskins W. Lee Hoskins is president and chief executive officer of The Huntington National Bank in Columbus, Ohio. This paper is given in honor of Ted Ba/bach and his service to the Federal Reserve Bank of St. Louis. His resolute pursuit of sound economics as the bedrock of monetary policymaking and his indomitable spirit, even when the policy process ran amok, has served us all welt I thank John Davis, Sandra Pianalto and members of the Research Department of the Federal Reserve Bank of Cleveland for helping to shape and advance my views on monetary policy during my four years with them. Views on Monetary Policy HE IDEAL MONETARY POLICY requires a efforts to coordinate monetary policies are credible and predictable commitment to main- likely to conflict with that objective. tain the long-term purchasing power of a currency. The performance of central banks, WHY CENTRAL BANKS? which have traditionally been entrusted with monetary policymaking, is far from this ideal What is the justification for a central bank? simply because a clear mandate for price-level Can some configuration of private institutions in stability—zero inflation—is absent. In practice, a so-called free-banking environment perform central banks serve as instruments that govern- the functions of a government-sponsored mone- ments use to pursue multiple objectives that they believe serve their interests. Therefore tary authority? Are central banks necessary? central banks pursue monetary policies that at In his 1959 Millar Lectures at Fordham best have only a fragile commitment to price University, Milton Friedman provided a classic stability. Governments are currently pursuing statement of the economic rationale for central policy coordination or monetary union strate- banks.’ Friedman’s argument appealed funda- gies that are little more than attempts to implement mentally to the costs inherent in a pure commodity- a regime of monetary protectionism, in the standard system, for example, a gold-standard global economy. The future of monetary policy system. These costs arise both from pure resource rests on the continuing struggle between politi- costs and perhaps more significantly from sub- cians seeking policies that serve their short-term stantial short-run price variability resulting from agendas and global financial markets that limit inertia in the adjustment of commodity-money the actions of an individual central bank. supply to changes in demand. The inefficiencies these costs represent are a significant disadvan- In my remarks I discuss why central banks tage of commodity-money exchange systems. have been established, their bias toward infla- tion and the importance of independence and As a consequence there is a natural tendency, accountability to their effectiveness. 1 also argue borne out by history, for pure commodity standards that zero inflation should be the dominant to be superseded by fiat money. But particular objective of a central bank and that current aspects of fiat money systems—such as fraudulent ‘These lectures were subsequently published as A Program for Monetary Stability. MARCH/APRIL 1993 44 banking practices, natural monopoly characteristics sider the advantages of improving the perform- and tendencies for localized banking failures to ance of central banks. The benefits of a properly spread to the financial system as a whole—resulted managed fiat currency are considerable, and the in the active participation of government. We have issue is or should be how to provide the central come to know this active participation as cen- bank with a proper charter to ensure policy tral banking. action that generates price-level stability in the long term. If such efforts fail, market alterna- Rationales for establishing central banks have tives should be sought. not gone unchallenged, not even by Friedman.’ Disruptions in payments can be costly, but so Because I am most familiar with the Federal are the instabilities and inefficiencies caused by Reserve, let me use it as an example. Before the the lack of an effective anchor for the price creation of the Federal Reserve in 1913, the level in fiat money systems. Moreover, ‘theoretical country prospered without a central batik. discoveries in finance and monetary economics, Broadly speaking, the impetus for creating the closer attention to the lessons of lustorical bank- Federal Reserve was a series of banking panics ing arrangements and advances in infot-mation that led to contractions in money and credit and financial technologies have contributed to a that in turn caused serious disruptions in eco- healthy skepticism about the supeiiority of central nomic activity. The nation sought to improve its banks and government regulation to alternative banking system by establishing a means for market arrangements. For example, some of the providing an elastic money in the context of a financial-backstop functions performed by central monetary standard based on full convertibility banks and banking regulators may have weakened to gold. The gold link was severely weakened private market incentives to control and protect by the Gold Reserve Act of 1934. against risk.’ The Federal Reserve was the result of a com- Stilt, those who argue for alternative monetary promise between those who would have kept structures must at least recognize that their the banking system entirely private and those case rests on untested propositions. Yes, it would who wanted government to assume a prominent be wrong to accept unthinkingly our current role in a rapidly growing economy. Other nations central banking system as the best alternative have grappled with the same problems and created for performing the monetary functions of advanced similar institutions. Today many republics of economies, but it would also be wiong to claim the former Soviet Union and several eastern Euro- that the current central banking system does pean nations are facing these same issues. We not reflect society’s choice of an institutional now have a world monetary system in which arrangement to perform those functions. governments, through central banks, monopolize It is not sufficient to argue that market- the supply and management of inconvertible oriented alternatives to oui current central fiat monies. banking systems functioned better in other times and places, for example, in 18th-century The displacement of the commodity standard Scotland.4 This begs the question of why such a that prevailed at the time the Federal Reserve was founded has exposed problems not other- system did not prove to be sustainable. Nor is it wise envisioned in 1913. For example, the price sufficient to argue that this system would have level has no anchor except fot that provided by prevailed if not for government intervention arid interference. This line of debate fails to the resolve of Federal Reserve policymakers. consider whether a political equilibrium that The quadrupling of prices since 1950 dramati- cally demonstrates the failure of Federal Reserve would support a market-oriented system in an advanced economy exists anywhere. policymakeis to provide such an anchor for the monetary exchange system. Fed policymakers’ It is premature to claim that some hypothetical commitment to price stability is neither as explicit monetary system can or should dominate institu- nor as strong as necessary for the successful tional arrangements that have already evolved management of a fiat currency. The gradual from extended political and economic experience. demise of our convertible monetary standard I believe that the prudent first course is to con- has brought us to a point that requires a basic 4 ‘See Friedman and Schwartz (1986) For a discussion of the free banking era in Great Britain, see White (1984). ‘See Goodhart (1988). FEDERAL RESERVE BANK OF ST. LOUIS 45 change to the framework within which the over time, the choice of targets or operating Federal Reserve functions if the benefits of a procedures probably only influences the variabil- fiat currency are to be achieved without large ity of inflation rates around a zero mean. In short, offsetting costs. a central bank that truly wants to achieve price- level stability can do it with any number of The evolution of the global monetary system operating techniques, as long as they control reflects a common, though unstated, acknowledg- money growth over time. ment that the benefits of a fiat monetary standard are substantial. Wise administration of that Perhaps a simple, and less elegant, explanation standard requires a central bank in some capacity. for persistent inflation is that central bankers are In this context, the essential issue is this: How can suffering from a Keynesian hangover. Centi-al nations achieve the benefits of a fiat money hankers, politicians and the public are merely standard and simultaneously consti-ain the exercise reflecting the prevailing economic dogma that of that power to the service of the public good? government has the responsibility and ability to Put another way: How can a nation prevent its manage aggregate output and employment, as central bank from debasing the monetary standard well as inflation. I have argued and continue to it is charged to protect? believe that a major source of price-level insta- bility comes from multiple objectives assigned to INFLATIONARY BIAS OF CENTRAL central banks—economic growth, employment, price stability and exchange rates. It is true that BANKS politicians pressure central banks to achieve dif- ferent objectives at different times. Such politi- The answer to these questions seems to elude us. cal pressure can produce inappropriate policy Witness the universal debasement of currencies actions; however, the responsibility for assign- by central banks since the loss of a commodity standard as a price-level anchor. To find the ing multiple objectives to central banks rests as much with the economics professions as it does answer, we must review central bank charters with politicians. For the last 50 years, many and the incentives provided to those who con- economists have supported various theories of trol monetary printing presses.