Constructing a Global Policy Norm: Monetarist Central Banking, ‘Stackelberg' Games in Monetary Economics, and the Discovery of “Credibility”

Thursday, 2 July 2015: 10:15 AM-11:45 AM
TW2.1.03 (Tower Two)
Leon Jesse Wansleben, London School of Economics, London, United Kingdom
This paper explores how inflation targeting became the global norm of central banking and, more specifically, how central bankers and monetary economists came to embrace idea that central banks can only effectively pursue anti-inflationary policies if they pursue ‘credible communication’.

In the light of contemporary unresolved problems associated with the politics of money, this convergence of theoretical views and political ideologies during the Great Moderation appears as a puzzling phenomenon (Borio, 2011). While there have recently been published interesting studies on inflation targeting as ‘independent’ and ‘communicative’ central banking (Holmes, 2013, Tognato, 2012), our understanding of how it has developed is still poor. Dominant strands of scholarship explain the spread of inflation targeting  by relying on two narratives: Scholars either argue that central bankers themselves discovered the virtues of inflation targeting through a learning process; or its spread is seen as the result of ‘performativity’, i.e. the translation of models of monetary economics into central banking.

The paper is based on the assumption that these two narratives are too simplistic: They fail to conceptualize the mutual feedbacks between expert discourses and central banking practices and the ‘emergent properties’ of norm formation. By contrast, the theoretical perspective proposed here emphases unpredictable intertwinements between conceptual and pragmatic innovation.

In an explorative study of these intertwinements, the paper reconstructs the emergence of one core idea of inflation targeting, namely the proposition that central banks need to be 'credible' in order to effectively control inflation. I here look at the feedbacks between evolving central banking practices in a particular country, Switzerland, and related expert discourses. This case is of high interest because, in the course of the 1990s, several high profile works in monetary economics discussed the Swiss monetary targeting and introduced the idea that it should be seen as the legitimate predecessor of inflation targeting (Laubach and Posen, 1997). What was particularly emphasized in these works was that monetary targeting had been successful because it had served as a means to credibly communicate the central bank’s anti-inflationary course. Swiss central bankers affirmed this post-hoc characterization. Arguably, this marked one important point of convergence, which contributed to the formation of a consensus around inflation targeting.

In my paper, I use the means of historical sociology in order to present a ‘teleology in reverse’ of this process. For this purpose, I rely on original research on the development of central banking practices at the SNB; and I study the theorization of the Swiss case in monetary expert circles by drawing on published papers, e.g. presented at monetary policy conferences organized by central banks or academic events.

I begin my empirical analysis by showing that, far from knowingly choosing a consistent strategy, the SNB, in the period of monetarist experimentation, had to cope with the difficulties emerging from its money supply control. It therefore started to use public communication in order to explain away failures and hide politically controversial decisions. The result was a set of monetary policy practices, which were superficially understood as monetarist, but at the same time sat uncomfortably with key monetarist propositions: To name just the most important 'inconsistencies', the SNB’s policy was based on discretionary decisions rather than a rule; and monetary targeting had more symbolic rather than technical value, as the SNB’s control over monetary processes was actually quite limited.

In that situation, post-monetarist ideas centring around the notion of credibility provided a resolve for the dilemmas of monetarist central banking. In particular, while these views affirmed the SNB public legitimacy as an inflation controller (Friedman, 2002), they justified the abandonment a technical control concept in favour of a much looser theory of control. Moreover, the discourse on credibility helped the Swiss central bankers to reframe their local practices according to a global discourse.

At the same time, monetary economists drew on the Swiss and other cases in order to resolve a dilemma within their own sub-discipline: By the 1970s, monetarists had largely succeeded in establishing inflation control as the primary problem of economic policy making. Theoretically, monetarists and neo-classicists had settled on the propositions that optimal monetary policy should follow a strict rule (i.e. a fixed annual expansion of money supply) and that policy activism, given that agents are rational, is doomed to failure. Kydland and Prescott (1977) gave these propositions an elegant game theoretic formulation. However, while theoretically convincing, these propositions were technocratic misfits: No central bank, including the monetarist ones, would strictly and passively adhere to a rule. From the late 1970s onwards, different theorists (Barro and Gordon, 1983, Fellner, 1979) reacted to this situation by drawing on the concept of credibility: They argued that while some central banks (e.g. the Fed) had to pay a high price for disinflation because they lacked credibility, others (like the SNB) had been able to bring down inflation in the absence of a strict rule-based policy because they had successfully established credibility.

Arguably, then, the very elusiveness of ‘credibility’ as a theoretical concept and normative ideal made it useful within the contexts of policy making and amongst monetary economists; this, then, provided a malleable, but important building block in the construction of a global policy norm.

Barro, R. J. & Gordon, D. B. 1983. Rules, Discretion and Reputation in a Model of Monetary Policy. Journal of Monetary Economics, 12, 101-121.

Borio, C. 2011. BIS Working Papers 353, Basle

Fellner, W. 1979. The Credibility Effect and Rational Expectations: Implications of the Gramlich Study. Brookings Papers on Economic Activity, 1, 167-178.

Friedman, B. M. 2002. The Use and Meaning of Words in Central Banking: Inflation Targeting, Credibility, and Transparency. NBER Working Paper Series. Cambridge, MA.

Holmes, D. R. A. 2013. Economy of Words: Communicative Imperatives in Central Banks, Chicago, University of Chicago Press.

Kydland, F. E. & Prescott, E. C. 1977. Rules rather than discretion: The inconsistency of optimal plans. The Journal of Political Economy, 85, 473-492.

Laubach, T. & Posen, A. S. 1997. Disciplined Discretion: The German and Swiss Monetary Targeting Framework in Operation. Federal Reserve Bank of New York Research Paper. New York.

Tognato, C. 2012. Central bank independence: cultural codes and symbolic performance, New York, Palgrave Macmillan.