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The Monetary Cosmopolitans

The Monetary Cosmopolitans

28.3.2014 18:22

Can you imagine a French citizen being elected President of the United States? Or a Japanese prime minister of the United Kingdom? Or a Mexican chancellor of Germany? Probably not. Indeed, even if there were no legal obstacles, it would be difficult to imagine voters in a democracy installing a foreigner in their government’s top job.

But, during the last few years, countries have increasingly turned to foreigners and people with considerable foreign experience to assume what is generally viewed as a country’s second most important position: head of the central bank. What has driven this shift, and should it be welcomed or discouraged?

For example, Stanley Fischer, nominated in January by US President Barack Obama to succeed Janet Yellen as Vice Chair of the Federal Reserve, is an American immigrant from southern Africa who served as Governor of the Bank of Israel from 2005 until last year. And, in July 2013, Mark Carney, a Canadian who had served as central-bank governor in his home country, became the first foreigner to lead the Bank of England in its nearly 320-year history.

Similarly, the widely respected governor of Ireland’s central bank, Patrick Honohan, spent nearly a decade at the World Bank in Washington, DC. One of Honohan’s deputies is a Swede with experience at the Hong Kong Monetary Authority; the other is a Frenchman.

This represents a major departure from the tradition of filling central banks’ top leadership positions with people who have spent most of their careers there – a tradition that, over time, allowed central banks to be taken over by “groupthink.” With the entrenchment of a particular ideology or mode of thinking, monetary policymakers increasingly missed – by choice or inertia – opportunities to change, reinvigorate, and improve the running of these vital institutions.

As central banks’ key role in the recovery from the post-2008 global economic crisis demonstrated, monetary policy must be flexible and innovative. That is where the different perspectives that foreigners bring can help.

The Fed’s experience – shaped by a historically decentralized power structure – highlights the benefits of a policymaking process characterized by diverse views. When the Fed was established a century ago, monetary authority was distributed across 12 regional reserve banks, each of which had considerable autonomy. The fact that the heads of each of the regional Fed banks were called “governor” – the same title given to heads of the long-established European central banks – was indicative of their authority.

But, in the aftermath of the Great Depression of the 1930’s, it became clear that such decentralization had prevented the Fed from formulating and implementing a coherent monetary policy. The heads of the regional banks were “downgraded” from governors to “presidents” – the first and only time in US history when the transition from governor to president was a demotion – and power was centralized in the Board of Governors based in Washington, DC.

Nonetheless, an important legacy of the earlier system has remained: each of the regional banks maintains its own research department, and brings a different approach to the monetary-policy debate. In other words, the Fed’s structure continues to foster a robust and diverse mix of views – something that is severely lacking in many other central banks.

Consider the Bank of Canada. Years ago, an employee at one of the regional Fed banks – who was also my graduate-school classmate – contrasted the responses to his research presentations in the United States and Canada. Whereas staff economists from the Federal Reserve System brought differing perspectives to the monetary-policy debate, their Canadian counterparts seemed to subscribe to a single “Bank of Canada view.”

Two independent reviews of the Bank of England published in the wake of the global financial crisis found a similar lack of intellectual diversity and robust debate. One observed that Bank of England staff members tended to “filter” their advice to make it more palatable to their superiors. The other concluded that the crisis highlighted just how wrong the consensus view had been, and recommended a new approach that considered divergent views. This desire for change may have contributed to Carney’s appointment as the new governor, and his recent decision to bring more outside expertise into the Bank’s leadership.

Avoiding groupthink is essential to developing innovative, effective policies capable of responding to new monetary-policy challenges – and that demands a flexible, dynamic policymaking process.

The good news is that central banks have options for enriching their policy debates, even without the benefit of the Fed’s size, structure, and geographic spread. For starters, they can establish committees of outside experts or commission regular external reviews of policy and the policymaking process. Such reviews typically take place only after a crisis – when it is already too late.

Another solution is to appoint a governor from outside the central bank, preferably one who has enough external experience to avoid being captured by groupthink.

Or, perhaps better yet, they can hire a foreigner.

Richard S. Grossman is a professor of economics at Wesleyan University and a visiting scholar at Harvard University’s Institute for Quantitative Social Science. His most recent book is WRONG: Nine Economic Policy Disasters and What We Can Learn from Them.

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