Review of Making Money: An Insider's Perspective on Finance, Politics, and Canada's Central Bank by John Crow

Review of Making Money: An Insider's Perspective on Finance, Politics, and Canada's CentralBank by John CrowAuthor(s): John Crow and David LaidlerSource: The Canadian Journal of Economics / Revue canadienne d'Economique, Vol. 36, No. 3(Aug., 2003), pp. 758-764Published by: Wiley on behalf of the Canadian Economics AssociationStable URL: http://www.jstor.org/stable/3131883 .Accessed: 16/06/2014 08:22

Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at .http://www.jstor.org/page/info/about/policies/terms.jsp

.JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range ofcontent in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new formsof scholarship. For more information about JSTOR, please contact [email protected].

.

Wiley and Canadian Economics Association are collaborating with JSTOR to digitize, preserve and extendaccess to The Canadian Journal of Economics / Revue canadienne d'Economique.

http://www.jstor.org

This content downloaded from 91.229.229.162 on Mon, 16 Jun 2014 08:22:30 AMAll use subject to JSTOR Terms and Conditions

http://www.jstor.org/action/showPublisher?publisherCode=blackhttp://www.jstor.org/action/showPublisher?publisherCode=ceahttp://www.jstor.org/stable/3131883?origin=JSTOR-pdfhttp://www.jstor.org/page/info/about/policies/terms.jsphttp://www.jstor.org/page/info/about/policies/terms.jsp

Review of Making Money: An Insider's Perspective on Finance, Politics, and Canada's Central Bank by John Crow

David Laidler Department of Economics, University of Western Ontario

Making Money is of obvious local interest, being the work of a governor of the Bank of Canada whose policies in the early 1990s generated almost as much controversy as did those of James Coyne three decades earlier. However, this gracefully written book deserves a world-wide readership among those inter- ested in central banks, because, as Stanley Fischer notes in his foreword, it brings an unusual perspective to bear on fundamental questions about what those institutions should be doing and about how they should be connected to political processes while they do it.

Readers of this journal will remember John Crow as an exceptionally tough- minded governor, who, beginning with his famous Eric Hanson Memorial Lecture in 1988, put Canada on course for 'price stability' (I don't think he ever actually used the phrase 'zero inflation' popularly associated with him), negotiated with the Mulroney government the introduction of explicit inflation targets in 1991, and withdrew as a candidate for a second seven-year term of office in 1993 because he was unable to accept the modifications to those targets that the newly elected Liberal government, in the person of its minister of finance, Paul Martin, thought desirable. Admire him or not, and there were many 'nots' around in the early 1990s, as Crow reminds his readers from time to time, hindsight requires us to recognize that he did more than any other policy-maker to establish the monetary stability that, once underpinned by sound fiscal policies after the 1995 federal budget, has provided the basis for Canada's much improved economic performance in recent years.

Crow's account of how the conduct of policy, and debates about it, looked to a key insider makes fascinating reading and reveals a few new historical details too. He tells us, for example, that the initiative to introduce explicit

Foreword by Stanley Fischer. Etobicoke ON: John Wiley. Pp.256 + xvi. $36.95 (Can.), $27.95 (U.S.). ISBN 0-470-83180-4.

Canadian Journal of Economics X Revue canadienne d'Economique. Vol. 36, No. 3 August i aout 2003. Printed in Canada Imprime au Canada

0008-4085 / 03 / 758-764 / ?Canadian Economics Association


http://www.jstor.org/page/info/about/policies/terms.jsp

Review of Making Money 759

inflation targets in 1991 did not come from the Bank of Canada, which was then under pressure from a host of critics to tell the public exactly what it meant by 'price stability,' and how long it intended to take to establish it. Rather, it originated in the Department of Finance, which was anxious about the short-run inflationary consequences that it thought might flow from the introduction of the GST. Crow also makes it clear that the sticking point in his negotiations with Martin about his reappointment was the latter's unwilling- ness to stand by his predecessor's commitment to the ultimate goal of an inflation rate of 'clearly less than 2 per cent.' There is a little light relief among the revelations, too: I had a good chuckle at Crow's tale of a suggestion made by someone, apparently seriously, that he be offered the ambassadorship to Russia as a means of getting him out of the way and his policies changed. Sadly, if he knows who had this hare-brained idea, he doesn't tell us.

But this is not, despite superficial appearances, anything approaching a 'tell- all' memoir. Crow's account of the events that led up to his replacement as Governor in 1993 by Gordon Thiessen is, for example, remarkably uninfor- mative about the role played in the affair by the Bank of Canada's board. That board, all of whose members were appointees of the previous government, must, as Crow does say, either have recommended his reappointment, or have made it clear to the minister that they were ready to do so. If it had not, the fateful discussion that Crow had with Martin about the future course of monetary policy, which ended in his not seeking another term, would never have taken place. It is inconceivable, moreover, that the board could have gone that far while being unaware of Crow's policy preferences or being unwilling to support them. Crow's failure to be reappointed thus involved the minister's declining to accept the board's choice and its subsequent recommendation that he be succeeded by Gordon Thiessen, second only to Crow himself in his degree of identification with the Bank's policies, was surely an interesting and even provocative response to this exercise of ministerial prerogative. Crow does not discuss any of this, presumably because, being a candidate for reappointment, he was not privy to the board's deliberations. But it is hard to believe that he was unaware of the tensions and the way that the board tried to deal with them. Crow's views on all this, and those of Governor Dodge, who was deputy minister of finance in 1993, would be well worth knowing.

In Crow's view, to have settled for an indefinite continuation of the 1-3% inflation target would not have been (and was not) a small compromise in 1993, but it would be a serious mistake to see his insistence on this point as confirming the once popular caricature of him as a man narrowly and even dangerously obsessed with price stability. On the contrary, his worries about this matter reflect an altogether broader set of concerns about how monetary policy is nowadays configured, not just in Canada, but in many other countries. Crow favours not just instrument independence for central banks but, unusually in the current climate of opinion, a high degree of goal independence. His views here are challenging and thoroughly thought out. They are



760 D. Laidler

also worthy of the greatest respect, even from those who, like me, find themselves uncomfortable with some of them, and the careful exposition they receive in Making Money is what makes the book such an important contribution to the literature on central banking.

In early 1993 most defenders of inflation targets in Canada heaved a sigh of relief that so much of the program remained in place after the election, and that the Bank of Canada still had a (albeit new) governor who was publicly committed to them. Neither outcome could have been taken for granted immediately after an election that had brought to power a Liberal government strongly committed to the wholesale reversal of the economic policies of its predecessor. And even a decade later, the recent rise in inflation notwithstand- ing, many of those defenders probably feel vindicated in that reaction. They would be inclined to ask whether things really would have worked out very differently in practice in the succeeding decade with an upper bound of 2% rather than 3% for the inflation targets.

Crow, however, sees the compromise reached about inflation targets in early 1993 as but one step in an ongoing and unfortunate process whereby the Bank of Canada lost a significant degree of autonomy to elected politicians - a group subject to incentives that are not conducive to good monetary policy in his view - during the 1990s, and he identifies the inflation targeting regime itself as part of the problem. There are two distinct questions here, which I shall discuss in turn: Has there really been a loss of autonomy? And if there has, should the fact be lamented or celebrated? To state my conclusions at the outset: Crow makes a strong case that the Bank has indeed lost autonomy, and to a greater extent than I had realized before reading this book; but where he laments the fact, I am inclined to celebrate it, though cautiously.

The Coyne affair had involved a disagreement over the conduct of monetary policy between the Bank's governor and the elected government of the day, and, after a bill declaring his position vacant had passed the Commons but failed in the Senate, it had ended with the governor's resignation. This episode had revealed a lack of clarity in existing law and practice dealing with the division of responsibility for monetary policy between the government and the central bank. In its wake, the doctrine of Dual Responsibility emerged. It was agreed that, in the normal course of events, monetary policy was a matter for the Bank of Canada, but that a minister of finance who disagreed with the course it was taking had the legal right to a final say in any argument. However, he could only exercise that right by issuing a written directive, cast in specific terms, to the governor, and, crucially, by having that directive published within two weeks of its being sent. On the governor's side, it was explicitly understood that the receipt of such a directive would trigger a resignation. The latter understanding considerably strengthened any gover- nor's independence, especially in the late 1970s and throughout the 1980s, when fiscal deficits were chronic, inflation was high, and unemployment was becoming a serious issue. In such circumstances, domestic political pressures




would tend to push any minister of finance towards monetary measures that would sustain, or even increase, inflation. Resistance from the govemor, however, could be overcome only by a directive, and it is not hard to imagine that a strong-minded governor, granted such cover and mindful of the suspicions that were growing in international financial markets about Canada's economic prospects, exercised a high degree not just of instrument independence, but also of goal independence, in his conduct of policy.

Seen from this perspective, then, the very institution of explicit inflation targets by joint agreement between the Department of Finance and the Bank of Canada in 1991 represented a significant loss of the Bank's goal independence, the importance of which became all too evident in early 1993, when a newly elected minister insisted on revising the targets in question over the objections of the then governor. Now, to be sure, the circumstances under which this occurred were very special. It was unusual, indeed utterly coinci- dental, for a governor's term of office to be coming to an end almost immediately after an election in which monetary policy had become an issue, but Crow is surely right that the argument that took place in 1993 was about much more than half a percentage point more or less on the average inflation rate.

Perhaps, also, it was this broader issue that Thiessen had in mind when, in 1996, he made it clear that any disagreements between the governor and the minister about the target value for inflation were subject to the dual responsibility doctrine, and perhaps it was also a factor in his decision to create the Governing Council as the Bank's policy-making body. It is, after all, harder to send a directive to set aside policy decisions that have emerged by consensus from a committee, even an informal one, than it is to overrule a single official. These steps, though, don't quite solve the problem that Crow would like us to think about, because before 1991 the governor clearly had the upper hand should it ever have come to an argument about policy towards the price level. Now that the principle of an inflation target set jointly by the government and the Bank is well entrenched, and now that this target has seemingly become stuck at a level that was initially presented as no more than a way station on the track to price stability, it is going to be very difficult for a Bank of Canada, intent on returning to that earlier goal, to win any arguments with a minister who prefers the status quo. In 2003 would a directive to maintain the inflation target at 2% rather than lower it to 1% be damaging to the minister who issued it? And would a threat from Mr Dodge to trigger such a directive by insisting on a lower target be credible?

It is also worth noting (though Crow does not) that the board that recommended the appointment of Gordon Thiessen in 1993 was, in the normal course of events, replaced by nominees of the Liberal government, and that two positions subject to ministerial review, namely, governor or senior deputy governor, were subsequently filled from outside the Bank. This is certainly not to suggest that those who were appointed to these posts are the kind of people who would act against their own best professional judgment to please a



762 D. Laidler

minister of finance, but it is to note that neither of them was, at his time of appointment, closely identified with the commitment to price stability that John Crow worked so hard to make an integral part of the Bank of Canada's culture.

Crow is surely right, then, that the Bank of Canada was better protected from political pressures in the late 1980s than it now is, and this does, indeed, make it more difficult for the institution to champion the pursuit of price stability as a fundamental principle of economic policy than it used to be. Let me here record my own preference for just that principle, but let me continue by immediately affirming that, nevertheless, I do not share Crow's dismay at how things have worked out in the 1990s. That is, first, because I believe that monetary policy should be judged not by its outcome alone, but also by the processes whereby it is made, which have value in and of themselves; and second, because I think that monetary policy processes have developed in a desirable direction in the 1990s. Nor am I convinced that this movement has come at any serious cost in terms of policy outcomes - at least not yet; for under current arrangements there will always be next year to worry about.

Crow's ideal central bank has a clear mandate to pursue price stability from the relevant political authority as well as the authority to give precise quantitative content to that mandate and to get on with the technical task of fulfilling it. A political liberal, in the old fashioned sense (albeit at the Whig end of the spectrum), could certainly approve of such an institution. Its political legitimacy would be beyond question, as would its ultimate accountability, in the sense that a failure to fulfil its mandate would surely lead to its autonomy's being withdrawn by the political authority that had granted it in the first place. The Deutsche Bundesbank, furthermore, which came very close to this model, had an excellent record of providing low inflation, and that is one reason why the European Central Bank was designed in imitation of it.

In contrast to this model, the Bank of Canada's formal mandate is notor- iously vague, and in the 1990s it has been replaced de facto by an extra-legal administrative agreement about inflation targets. The Bank thus shares the responsibility for setting the quantitative goals of monetary policy with politicians but retains instrument independence. Crow is critical of this untidy arrangement, but there are nevertheless a few things to be said in its favour. To begin with, 'price stability' is a rather elastic term, and the quantitative content given to it is surely a matter of legitimate, ongoing concern to any electorate and also is a legitimate matter for an ongoing political debate whose ebb and flow can influence the policy choices that actually get made. The problem with politically subservient central banks like the post 1945 Bank of England, which delivered such poor inflation performances, was that their policies were too heavily influenced not so much by politicians intent on generating inflation, but by politicians who were never forced to confront the overall consequences for the inflation rate of the other policies they were implementing. Under a regime where politicians have a major say in setting




explicit targets for inflation, those consequences must always be on their agenda. Explicit targets transform the inflation rate from a slack variable that reflects the unconsidered aggregate consequences of a host of other policy choices into a self-imposed constraint upon them. The recently reformed Bank of England is still completely subservient to politicians in its choice of goals, but the politicians have now taken it upon themselves to state them in terms of explicit inflation targets, and so far the experiment has been a success.

To be sure, a self-imposed constraint can always be shifted by the politicians who are subject to it, and under current conditions the Bank of Canada's commitment to stable prices cannot be as complete and secure as Crow would like it to be. The value of any policy goal that is subject to political influences needs to be continuously explained and defended, which is surely one reason why the Bank of Canada has paid so much attention to what it calls the 'transparency' of the policy-making process in recent years. But the contrast here with Crow's preferred arrangement is by no means absolute. Even, indeed particularly, the Bundesbank made a continuous effort to communicate directly with the community it served, as does the ECB.

An arrangement under which the central bank's goal independence is seriously attenuated has one great political advantage. If the population and its elected representatives, for good or even bad reasons, decide that the policy goal needs to be changed, the mechanisms for doing so are readily available. This is not so easy when a central bank with goal independence finds itself at odds with the population it is supposed to serve. The Coyne affair ended in an outright political crisis, and debates about Crow's policies came close to doing so as well. That is why the Bank of Canada briefly became an issue in the post-Meech Lake constitutional debate. Moreover, I conjecture that Europe is going to have trouble dealing with the political tensions that seem to be arising between the ECB, whose independence is currently guaranteed by an extremely hard-to- amend treaty, and politicians in certain member countries, who find that its policies create serious difficulties for the populations they represent, given the other policy preferences that those populations have expressed at the ballot box.

The major policy problem in Crow's view is the provision of stable money while maintaining the politically legitimacy of the Central Bank. His book makes a strong case for the importance of this problem, and his warnings that the progress that Canada has undoubtedly made towards price stability in the last fifteen years or so is anything but secure are very well taken. And, it should be noted, his views on the importance of political legitimacy play a role in the strong case that Crow makes for Canada's maintaining its own currency in North America. He is not one of those who want monetary policy to be made for Canada by an authority that is not accountable to the Canadian people.

Even so, I am less inclined than he is to treat the problem of achieving monetary stability in a democracy as one that can be solved by editing central bank mandates, redrafting memoranda of understanding with finance minis- ters, or reconfiguring institutions to maximize the distance between politics



764 D. Laidler

and monetary policy. Scott Gordon, who was a major academic participant in the debates created by the Coyne affair, frequently stressed the importance of distinguishing between policy problems that can be solved, and those that have to be coped with, and he also warned of the dangers inherent in confusing one with the other. Taking that lesson to heart, I am inclined to think that the task of achieving monetary stability in Canada is one to be dealt with in two steps: first by establishing a framework resilient enough to cope with the ongoing tensions inherent in the fact that the goals of monetary policy are legitimate matters for an ongoing political debate during which people might sometimes change their minds; and second, by continuously engaging in that political debate. Seen from this perspective, there has been considerable progress over the last fifteen years or so in Canada, not just in the outcomes of policy, but also in the processes whereby it is made. And if the nature of the processes in question introduces a certain element of fragility into the outcomes, that, it seems to me, is simply a fact of life in a democracy.

John Crow did not get the credit he deserved for his contribution to restoring order to Canadian economic policy when he was governor of the Bank of Canada. Perhaps the contribution that he has made with Making Money to keeping debate about these matters lively and provocative will bring him greater kudos. He has certainly earned it.



Article Contentsp. [758]p. 759p. 760p. 761p. 762p. 763p. 764

Issue Table of ContentsThe Canadian Journal of Economics / Revue canadienne d'Economique, Vol. 36, No. 3 (Aug., 2003), pp. i-ii+523-766Front Matter [pp. i-i]Product Differentiation in Successive Vertical Oligopolies [pp. 523-545]The Closed-Loop Effect and the Profitability of Horizontal Mergers [pp. 546-565]R&D, Innovation, and Technological Progress: A Test of the Schumpeterian Framework without Scale Effects [pp. 566-586]Decentralizing Hydro Power Production [pp. 587-607]Eco-Labelling Scheme, Environmental Protection, and Protectionism [pp. 608-633]Export-Market Participation and Productivity Performance in Canadian Manufacturing [pp. 634-657]Product Differentiation and the Gains from Trade under Bertrand Duopoly [pp. 658-673]International Capital Flows under Asymmetric Information and Costly Monitoring: Implications of Debt and Equity Financing [pp. 674-700]Smuggling, Non-Fundamental Uncertainty, and Parallel Market Exchange Rate Volatility [pp. 701-727]Growth and Unemployment in a Shirking Efficiency Wage Model [pp. 728-746]Goods Market Responses to Trade Shocks and Trade and Wages Decompositions [pp. 747-757]Review of Making Money: An Insider's Perspective on Finance, Politics, and Canada's Central Bank by John Crow [pp. 758-764]Back Matter [pp. 765-766]

Documents

Review of Making Money: An Insider's Perspective on Finance, Politics, and Canada's Central Bank by John Crow