CENTRAL BANKING

Central Banking In Theory And Practice

Central Banking In Theory And Practice

Introduction

Alan Blinder is a professor of economics at Princeton University. He has co-authored with William Baumol a widely used principles-of-economics textbook. He is an articulate and prominent New Keynesian economist. And he recently served as vice chairman of the Board of Governors of the Federal Reserve System. Indeed, he epitomizes in many ways John Maynard Keynes's own ideal of a policymaker: highly intelligent; seemingly unbiased and dispassionate, while possessing a strong sense of doing service for "the public interest"; and persuaded that, while there are important strengths in the private-enterprise system, government intervention in the market is essential to maintain economic stability and growth.

Discussion

Professor Blinder conveys just the right amount of modesty in admitting the limits of both economic theory and historical evidence to prevent any impression of ideological dogmatism. But just below the surface, he suffers from that "pretense of knowledge" that Friedrich A. Hayek pointed out almost always underlies the thinking of the social engineer and the political manipulator of the market.

Starting from the assumption that society needs a central bank to keep the market economy on a stable trend of full employment, low inflation, and economic growth, Professor Blinder explains what he considers the way a central banker should operate. To begin with, he should realize that he is pursuing multiple goals at the same time, so they will have to be balanced against each other. Second, he must have an econometric model (a statistically constructed conception of market interrelationships) to project into the future, to estimate both where the economy seems to be going and what the impact would be if policy tools at the Federal Reserve's disposal were applied in various quantitative ways.

He admits that no one knows the "correct" statistical model of a modern complex market economy. The interrelationships are too intricate and the quantitative interconnections are constantly changing owing to shifts in various factors on both the supply and demand side of the market. So his answer is simply to simulate through the computer as many of the different econometric models as possible, exclude any extreme results, and then operate on the basis of an average of all the rest.

The heart of the Blinder's argument in the first lecture is that central banks must develop monetary policy to address the short-term economic issues but only as part of a long-term strategy. Central banks should take one step at a time, make that step a conservative one, be thinking of the next steps, but be flexible in their willingness to change those next steps if new data suggest the original policy is now inappropriate. His second lecture argues that central banks should use manipulation of the interest rate rather than the money supply as the means to steer the economy. He grounds these arguments in economic theory, but the logic of his arguments is clear.

His final lecture defends the independent role of central ...