We owe the Central Bank a debt of gratitude for pursuing the second option.

Is human mind so advanced to come up with a theory that will never change? Please leave the 'isolated' world of theories and meet the chaos of the real life. Can you draw an inalterable implementation framework based on a theory?

An example for monetary policy: Why was there the gold standard in the decades preceding the World War I and why was the standard then abolished? How did the exchange rate policy shift after the World War II towards a system where the value of currencies was pegged to US dollars occur? Why did the system collapse? How did central banks get caught by the 'monetary control' trend in which money supply is sought to be controlled? How was this trend replaced by a new one, namely the inflation targeting policy? Are such trends long-lasting? How did we come from an era in which state's intervention in the economics was seen necessary to a milieu in which everyone believes that the market is almighty and thus needs no intervention? How come did this belief collapse recently? 

Circumstances are changing
There are many questions here; but there is one common answer for all: 'Change is inevitable.' If the knowledge at hand does not help us to keep up with the changing circumstances, we embark on a quest. We take risks; we grope around on our way and then set a new implementation framework.

So let me focus on the present and limit myself to monetary policy: first, circumstances have changed considerably when compared to the 'period before the global crisis'. Central banks of developed countries have been throwing money around in all sectors. Since interest rates in developed countries stand at historically lowest levels and as their economy did not recover yet, the liquidity injected there seeks new channels to flow.

Second, everything did not yet fall into place. Will the idea that the market is almighty and should be free of any intervention, which was harmed severely during the global crisis, have a death blow and the risk appetite of financial institutions in particular will be limited? Or will the financial sector which is highly powerful in political circles remains as a law unto itself? We do not know the answer yet.

Third, the EU is shaken. If the 'great' leaders of the EU maintain their pace in the way to the collapse of the Union, would the crisis deepen and turn into another global crisis affecting the whole world? Will monetary expansion be kept or reverse? When will the interest rates be pushed upwards again? 

Give the Bank its due
Assume that you are a bureaucrat at the Central Bank. You realize that the given milieu incurs risks for the financial system. Uncertainties can rise to the skies any time. You have problems pertaining to price stability; you are not at ease but you have a good chance to save the day. However, if the potential risks concerning the financial system take place as you anticipated, the economy will be facing harsh times.

What would you do then? Would you say 'I cannot break the routine; my sole purpose is to maintain price stability'? Or would you try to establish an implementation framework which takes into account price stability together with financial stability in line with the changing circumstances to the extent that the relevant law allows? If you are 'design-disabled' and lack courage, you continue the routine as if the status quo did not change at all. But if you have the sense of responsibility and courage and of course if you have a running mind, you take risks and try to establish a new framework in tandem with the changing conditions.

We owe the Central Bank a debt of gratitude for pursuing the second option. We can attract attention to the risks and guide them in making the new implementation framework more efficient through our critics; but we should give the Central Bank its due.

This commentary was published in Radikal daily on 23.12.2010