Published by EH.NET (May 2003)

Pierre L. Siklos, The Changing Face of Central Banking: Evolutionary Trends since World War II. New York: Cambridge University Press, 2002. xix + 347 pp. $70 or ?50 (hardback), ISBN: 0-521- 78025-X.

Reviewed for EH.NET by Richard C. K. Burdekin, Department of Economics, Claremont McKenna College.

Ideally, a new book on central banking in the postwar era would do more than just set out the evolution of central bank laws and policy actions. It would add perspective by relating these events to changes in the exchange rate regime, fiscal and political pressures, and macroeconomic trends in the countries concerned. It would also relate the evolution in policymaking to developments in macroeconomic analysis and incorporate the new emphasis on such issues as accountability, transparency and the ascendance on inflation targeting. Finally, the book would have sufficient rigor to satisfy academics and yet be accessible to undergraduates and practitioners. Remarkably, in this volume Pierre Siklos of Wilfrid Laurier University has done all of these things and more. This is a tour de force that deserves to be the standard reference on central banking for many years to come.

The volume begins with a broad overview of the development of central banks over the postwar era, their governing structures and key trends in inflation performance, the real economy and interest rate setting over the decades. The author communicates an unusually rich understanding of twenty central banks and countries, covering most of the major industrialized economies, and also relates his analysis to the set up of the European Central Bank. Tests for shifts in inflation persistence suggest that, on average, more independent central banks are associated with lower inflation persistence. Common inflationary trends across countries are explored in relation to such factors as changes in the exchange rate regime and the widespread adoption of inflation targeting in the 1990s. The author also points out that “mean inflation rates across countries are lower in the 1990s than in the 1960s while mean nominal interest rates are, on average, higher in the 1990s than in the 1960s” (p. 64). Although this does not in itself prove that monetary policy became too tight, it does seem that 1990s real interest rates remained high by historical standards.

Siklos challenges the importance of personalities in central bank policymaking. Empirical results suggest that exceptionable episodes of monetary policy appear to be more a response to crisis than evidence of a systematic importance of the particular individuals involved. For example, Paul Volcker’s standout role as an “inflation fighter” is statistically similar to that played by many other “inflation fighters” who also took office in the late 1970s or early 1980s. To say that these individuals were a product of their times does not, of course, mean that they do not deserve credit for what they accomplished. And the author later points to Volcker’s success in breaking inflationary expectations even though “many of the benefits and the prestige conferred on the Fed would accrue to Volcker’s successor, Alan Greenspan” (p. 97). Typical of the level of detail featured throughout the volume, the author’s analysis includes information on the average tenure at each central bank and even a table characterizing the record of each individual governor. Additional case studies detail developments in Canada and Germany, as well as the United States.

Actual central bank policymaking is modeled based on the popular “Taylor rule,” whereby central banks raise interest rates when inflation rises above target as well as when real output rises above (or, alternatively, unemployment falls below) its sustainable target level. Siklos estimates forward-looking “forecasts” of inflation, output and unemployment for each country and allows for the influence of inflation abroad. The almost bewildering array of specifications includes testing for variation by exchange rate regime or by decade, and allowing for partisan or electoral influences on monetary policy, fiscal pressures, and an impact of interest rate volatility. Interestingly, more than half the central banks appear to be systematically influenced by changes in government control (partisan effects) or the electoral cycle, including the supposedly independent central banks of Germany and the United States. Perhaps the most striking feature of the empirical work is not, however, the differences in behavior across countries but rather the similarities. Not only are the actual interest rate paths shown in Figure 4.2 (p. 176) well explained by the author’s model but also cross-sectional “panel” estimation suggests that there is a common “group” response to variables like inflation and unemployment “shocks.”

Just as individual central bank governors seem to stand out only in times of crisis, fiscal and exchange rate pressures prior to the 1990s may help to explain more heterogeneous behavior in the earlier postwar decades. It may not be coincidental that greater consensus in favor of anti-inflationary policies emerged at a time of reduced economic stress. Moreover, “it is telling that de jure independence is a phenomenon that appeared to gather momentum after a consensus had been reached to reduce inflation, and not as a direct vehicle through which lower inflation per se was attained” (p. 269). Even though the new institutional arrangements implemented in a number of countries in the 1990s may have followed the anti-inflationary trend, rather than leading it, the author nevertheless identifies tangible benefits stemming from increased transparency and accountability — in particular, the adoption of inflation targets and the release of information on inflation forecasts and monetary policy strategy. Once again a wealth of institutional detail is offered on the communication strategies adopted by all the central banks under study.

Overall, the 1990s saw the central banks in the major industrialized countries not only behaving more similarly but also apparently at the top of their game. The European Central Bank is portrayed as something of an anachronism, however, insisting on “a prominent role for money growth and a range of other economic indicators” (p. 308). Other economists may argue that a focus on money growth is not necessarily any less consistent with inflation targeting than is a reliance upon interest rates. After all, interest rate setting has its ambiguities too — do lower rates imply expansionary policy or simply a validation of disinflationary (or even deflationary) pressures? And, historically, the German Bundesbank arguably combined these two features well before the 1990s. Beginning in 1975, the Bundesbank provided information on both its money growth target and a so-called “unavoidable rise in prices” that could reasonably be interpreted as an inflation forecast if not an early form of inflation targeting. (For an early suggestion that the Bundesbank anchored inflation expectations with their announced “unavoidable rise in prices,” see Rudolf Richter and Frank Diener, Weltwirtschaftliches Archiv, 1987).

Leaving aside the role of money growth, should we expect the favorable perspective of the 1990s to be maintained? Two obvious concerns spring to mind. First, given that fiscal and political pressures seem to have produced looser monetary policy in the past, will the same thing happen again if the deficit expansion of the early years of the twenty-first century continues? Second, to the extent that new monetary policy arrangements help prevent this, will inflationary targeting regimes also be effective in warding off the other threat that has emerged — deflation? Indeed, the most vehement recent criticisms of the European Central Bank seem focused less on the methods than on the monetary policy outcomes themselves, which have, if anything, looked to be too tight. Based on the present volume, it is doubtful that anyone is better qualified than Professor Siklos to assess central bank performance in light of these new trends. While enjoying the present book, we can also hope that more is to come. For the moment, in addition to the excellent detail and analysis, readers will enjoy an outstanding bibliography and an extremely well-stocked dedicated website, not to mention some well-chosen quotes. Let me conclude with my favorite of these: “One is reminded of a former governor of the Bank of England who, when asked: “Do you feel your bank has the right to defy the government?” replied, “Oh, yes, we value that very highly — and wouldn’t think of exercising it” (p. 86).

Richard C. K. Burdekin is Jonathon B. Lovelace Professor of Economics at Claremont McKenna College. His main research interests include inflation and deflation, central bank policymaking and Chinese economic reforms. Recent articles include “Inflation Is Always and Everywhere a Monetary Phenomenon: Richmond vs. Houston in 1864” (with Marc D. Weidenmier), American Economic Review (December 2001) and “German Debt Traded in London during the Second World War: A British Perspective on Hitler” (with William O. Brown, Jr.), Economica (November 2002).