Interview with Athanasios Orphanides, Governor of the Central Bank of Cyprus, conducted on 25 October 2007 by Ralph Atkins and Mark Schieritz, published on 29 October 2007
Q. What lessons can the ECB learn from the US Federal Reserve or visa versa?
The ECB developed out of what we have learnt in the history of central banking, including the experience of the Federal Reserve and in my view incorporates many of the best elements of these historical lessons.
Q. Looking at the events of recent months, do you think that the ECB can learn from the mistakes that the US Fed might have made in its monetary policy since 2001?
It is awfully early to identify with any reasonable accuracy whether - or when - monetary policy mistakes have contributed importantly to the troubles that we have seen in the last couple of months. It is true that we did have a significant re-pricing of risks in August but I have to remind you that the risk premiums were actually very low and policymakers have been pointing out for quite some time just how exceptionally thin margins seemed to have been in some markets.
Q. Should central bankers be looking more closely at asset prices?
I think that it is quite sufficient and good practice to focus on the information that we have on asset prices for inflation and economic activity. Asset prices are useful and contain information, for example, on whether risks to economic activity could be on the downside - which is arguably an element of the current environment. But from time to time I see statements such as 'shouldn't central bankers try and identify nascent bubbles in financial markets and respond to them' and I think our models are not that good in identifying such situations in real time. I don't think that we can outguess the markets on what is normal and what is not normal with sufficient accuracy to serve as a policy guide.
Q. What lessons then can you draw from the recent financial market turmoil?
It is too early to draw conclusions from the recent experience. Additional time is needed to develop a more complete picture. There are some early conclusions that we can draw - although we may revise them as we accumulate more information. One of them is that greater transparency may be helpful in a number of areas.
Q. Banks have been arbitraging between the different central bank collateral regimes. Does there need to be more coordination between central banks?
Financial markets are quite free, and there are arbitrage opportunities. These are elements of the flexible dynamic economy that we have and I think that ultimately they enhance the world economy. So I'm not sure if there is something negative that I would identify. Imposing artificial restrictions is rarely a good idea for improving the way things work.
Q. Perhaps this is a good reason why the UK should join the eurozone?
I would most definitely welcome all members of the EU who have not yet joined the euro area and I am certainly thrilled that Cyprus is joining the euro area. For Cyprus this is a tremendous achievement that in my view will add to the wealth of the island. I see only net gains. The benefits of adopting the euro are not something that you realise overnight but the long- run benefits in my view are tremendous.
Q. Based on your experience at the US Fed, does the ECB have the right approach on the role of money in its monetary analysis?
Absolutely. As Milton Friedman taught us, inflation is a monetary phenomenon. There are benefits in paying attention to money and credit aggregates. It doesn't mean that monetary aggregates are a determining factor in monetary policy from month to month.
Paying attention to monetary aggregates and guiding policy decisions by drawing on monetary aggregates is how Paul Volcker's Fed managed to bring inflation down and successfully dis-inflate the US economy. So money has been useful in the US over a different period. At the same time, depending on the institutional environment and the financial innovation we have around us, the usefulness of any particular aggregate as an indicator changes over time. Sometimes it can be quite uncertain what the short-term link is between monetary aggregates and inflation. I remember such an experience when I was an economist at the US Fed during the early 1990s, which led the Federal Reserve to de-emphasise the role of monetary aggregates at that time. Of course, this depends critically on the specific institutional arrangements.
Q. You identified the under-pricing of risks before the recent financial market turmoil and we have seen a correction. Was there more that central banks could have done to avoid such a disruptive correction?
This is a difficult question to address. Knowing what we now know, policymakers probably could have taken decisions that might have avoided some issues. But that is not the real question. The issue is: knowing what a policymaker knew at the time, could you have done better? It is not clear to me that policy decisions could have been better. This is related to your earlier question about whether there were policy decision mistakes - for example in the US - that we could identify as having caused or led to the current turbulence. I don't think that we can do that. Again in real time it is awfully hard to identify what is the normal pricing of risk. Risk premia in several markets were quite low but that was not sufficient basis for predicting at what point - this summer, a year from now, or in ten years - we would see a re-pricing.
Q. What is the biggest difference you see now that you are at the ECB?
The biggest difference in my view is the clarity of the ECB's mandate. What the founders of the ECB incorporated into its mandate is the essence of what we have learnt from monetary history in the past 100 years. The clarity of the mandate makes it easier in my view to take the correct monetary policy decisions with much greater confidence, which allows monetary policy to best contribute to the welfare of nations.
Q. Could the Fed learn from this clarity of the mandate?
Unfortunately this is an institutional question. The Fed's mandate is something that is given by the Congress in the US. There have been attempts over the years to clarify the Fed's mandate and to state price stability as the primary objective of the Fed. If you go back and study the record in the early 1990s, for example, there was a discussion in Congress along these lines. Chairman Greenspan actually supported that effort but it is not up to the Fed to decide.
Q. Some European politicians say the central bank should look more at output?
This is what is so powerful about designing a central bank with a clear price stability mandate. The primary benefit from that is that it insulates day-to-day policy decisions from the cyclical influences that might be linked to the electoral cycle in a specific region or a country as a whole. The beauty of the design is that you have an independent central bank with a strong price stability mandate and you avoid all those complications and achieve better outcomes in the long run.
Q. Will Cyprus's entry into the eurozone, alongside Malta, change decision-making in the council? You will have lots of smaller countries with the same voice as Germany?
The institutional framework of the eurosystem fosters collegiality and the degree of professionalism at meetings is impressive. Ultimately, I don't think that it particularly matters what corner of Europe any particular person comes from. All of us share a common objective and that is to set monetary policy as best as we can for the euro area as a whole. You compared Cyprus and Germany: there is sense in which I, coming from Cyprus, will now have to pay a lot of attention to Germany simply because it is a large part of Europe.
Q. Does consensus-based decision- making slow you down?
I don't think so. The size of the Governing Council is about the same as the FOMC and I'm not sure that you could accuse the FOMC of having a decision making process that is slow relative to other decision making bodies. And the FOMC has operated like this since 1935. I don't think that the Governing Council is much different in that regard.