CENTRAL BANKS IN THE 21st CENTURY An international conference sponsored by the Banco de España Edited by S. Fernández de Lis and F. Restoy Central banks in the 21st century Madrid, 8-9 June 2006 Central banks in the 21st century An international conference sponsored by the Banco de España Madrid, 8-9 June 2006 Edited by Santiago Fernández de Lis and Fernando Restoy All rights reserved. The contents of this publication are protected by Spanish law, which imposes prison sentences and/or fi nes, in addition to the related damages, on whosoever should reproduce, plagiarise, distribute or publicly communicate, in its en- tirety or in part, a literary, scientifi c or artistic work. Such works may not be modifi ed, interpreted or their performance reproduced or communicated in any medium without express permission. © Banco de España, 2006 Calle Alcalá, 48. Tel.: 91 338 50 00; 28014 Madrid www.bde.es Legal deposit: M. 48.211-2006 Printed in Spain by Artes Gráfi cas Coyve, S.A. Avénida de Córdoba, 21. 28026 Madrid. CONTENTS Foreword ................................................................................................................ 9 Miguel Fernández Ordóñez, Governor of the Banco de España Introduction: conference summary ..................................................................... 11 Santiago Fernández de Lis and Fernando Restoy, Banco de España MONETARY POLICY Monetary policy today: sixteen questions and about twelve answers ...... 31 Alan S. Blinder, Princeton University and Promontory Financial Group Comments Vítor Constâncio, Banco de Portugal ................................................................ 73 Lucas D. Papademos, European Central Bank .................................................... 87 Raghuram G. Rajan, International Monetary Fund ........................................... 99 Activism and alertness in monetary policy ..................................................... 107 Jean-Claude Trichet, European Central Bank PAYMENT AND SECURITIES SETTLEMENT SYSTEMS Drivers for change in payment and securities settlement systems .......... 127 Gertrude Tumpel-Gugerell, European Central Bank The challenges of integration in Europe ......................................................... 133 Alberto Giovannini, Unifortune Asset Management Recent developments and policy challenges affecting ................................ 153 large-value and retail payment systems in Europe Christian Noyer, Banque de France A United States perspective on the changing pattern of payments .......... 161 Anthony M. Santomero, Federal Reserve Bank of Philadelphia CENTRAL BANKS AND GLOBAL IMBALANCES José Manuel González-Páramo, European Central Bank ............................... 177 Vittorio Corbo, Banco Central de Chile ............................................................ 187 Vincent R. Reinhart, Federal Reserve Board ...................................................... 195 Axel A. Weber, Deutsche Bundesbank .................................................................. 205 FINANCIAL STABILITY Financial stability and globalization: getting it right ..................................... 215 Frederic S. Mishkin, Columbia University Comments Erkki Liikanen, Suomen Pankki .......................................................................... 255 Malcolm D. Knight, Bank for International Settlements .................................. 263 Guillermo Ortiz, Banco de México .................................................................... 269 CONCLUSIONS Jaime Caruana, Banco de España ......................................................................... 279 Pedro Solbes, Second Vice-President of the Spanish Government ........................ 287 and Minister for Economy and Finance Contributors ........................................................................................................... 293 Foreword Miguel Fernández Ordóñez Governor of the Banco de España n - June , a Conference under the heading “Central Banks in the O21st Century” was organised in Madrid to commemorate the 150th anniver- sary of the adoption of the name Banco de España by the Spanish Central Bank. The Conference was held under the term of office of my predecessor, Jaime Caru- ana, who provided firm backing for the event and followed the preparation of the programme and all related organisational work very closely. The Conference enabled participants to discuss in depth and with a long-term perspective the main issues surrounding central banking today in the areas of mon- etary policy, payment systems and financial stability. A discussion on current mac- roeconomic imbalances and their impact on world economic trends, with particu- lar focus on central banks’ tasks, added an appropriate shorter-term perspective of present economic policy challenges to the programme. This volume presents the Conference proceedings which, I believe, will contrib- ute to promoting discussion and understanding of the main challenges currently facing central banks and, hopefully, to inspiring possible policy-making improve- ments. We appreciate the outstanding contributions of all those who participated in the symposium, helping shed light on very complex and relevant topics. Finally, let me convey my special thanks to all the staff involved in the design and organisa- tion of the conference. Introduction: conference summary Santiago Fernández de Lis and Fernando Restoy1 Banco de España his book contains papers and proceedings from the Conference organ- Tised on 8-9 June 2006 to celebrate the 150th anniversary of the adoption of the name Banco de España by the Spanish Central Bank. On this occasion, dis- tinguished public officials, central bankers, academics and financial market par- ticipants met in Madrid to exchange views on the changes in the role played by central banks in the recent past and the challenges ahead in the new century. The Conference permitted participants to discuss in depth the main issues currently shaping the monetary policy debate, along with other matters of great relevance to central bankers. In particular, the programme included sessions on Payment and Security Settlement Systems and Financial Stability. Moreover, there was a panel discussion on how current macroeconomic imbalances affected the economic out- look and the extent to which this was relevant for central banks. In what follows we summarise the papers presented and the discussions held at the Conference. Monetary Policy In the session on monetary policy, chaired by Governor Jaime Caruana, Alan Blinder presented an issues note dealing with up to sixteen relevant questions. The paper contained what proved to be relatively uncontroversial arguments in favour of collegial monetary policy decision-making committees, the involvement of central banks in banking supervision, the gradualist approach for interest rate decisions, the need to lead rather than follow markets and other issues. The commentators, however, focused their remarks on a few questions on which they presented their own nuances or sometimes contradictory views. These mainly related to the objective function of 1 We wish to thank all staff involved in the organisation of the conference. In particular we are grateful to Oscar Arce, María Jesús Fernández, Regina Martínez and Juan Luis Vega for their support. 12 Central banks in the 21st century central banks, the selection of core versus headline inflation as a target variable, the limits to central bank transparency and the extent to which monetary policy should take into account relevant financial developments, such as asset price bubbles. Regarding the loss function for central banks, Blinder made a case for central banks becoming more transparent about their policy objectives. In that respect he set out different practical and theoretical arguments which, in his view, would ad- vise central banks to adopt something close to a quadratic loss function in which both inflation and unemployment (or output) deviations from target would ap- pear as arguments. He would however accept that, in a systemic crisis scenario, central banks should depart from the regular objective function and give priority to financial stability considerations. Governor Vítor Constâncio expressed reservations on the proposal to ask cen- tral banks to make explicit their own loss functions. First, using results by Michael Woodford, he highlighted several theoretical points. In particular, he reminded the audience that a loss function between inflation and the output gap was only a good approximation to consumers’ welfare under specific assumptions, such as the absence of frictions other than sticky prices and the presence of cost-push shocks. Moreover, he recalled the practical difficulties of deriving robust estimates of the output gap. As a consequence, he preferred central banks not to be committed to a specific loss function or to a concrete instrument rule. ECB Vicepresident Lucas Papademos considered that the quadratic loss function proposed by Alan Blinder did not permit a realistic description of central bankers’ behaviour and introduced unnecessary constraints. In particular, he stressed that the ECB did use a hierarchical ordering of objectives – in which price stability had an overriding importance – and recalled the underlying proposition that, in general, price stability contributed to reducing output volatility. A second issue, related to some extent to the previous one, was the use of either headline or core inflation in the definition of central bank