Capitalisn’t: The Reluctant Central Banker

Kate: So, Paul, why are you trying to impose constraints on yourself?

Paul Tucker: I believe in democracy. It’s a precious—

Luigi: This makes him even more unique, a central banker who believes in democracy.

Kate: Hi, I’m Kate Waldock from Georgetown University.

Luigi: And I’m Luigi Zingales at the University of Chicago.

Kate: You’re listening to Capitalisn’t, a podcast about what’s working in capitalism today.

Luigi: And most importantly, what isn’t.

Kate: Should I introduce Paul?

Paul Tucker: Only use the Sir once, but only once. Okay?

Luigi: Sir Paul.

Paul Tucker: Yes. Luigi carries this off with the appropriate derision that a European knows how to deliver.

Kate: Okay, I had a plan for the Sir. Ahem, today we’re joined by Sir Paul Tucker, an economist who is the former deputy governor of the Bank of England from 2009 to 2013. He’s now a fellow at Harvard’s Kennedy School and Harvard’s Center for European Studies. He’s also the first knight I have ever spoken to, which has me swooning. He has a new book, Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State. So, welcome to the show, Paul.

Paul Tucker: Well, thank you very much for having me here.

Luigi: Paul is unique in many dimensions, but I think one I want to share with my listeners: generally retired, important figures like Paul write memoir books that are pretty boring. They sell very well. They make them rich, but they’re pretty boring, and they tell the gossip of what was going on when they were in power. Paul has written a book which is exactly the opposite of this; it is a scholarly book where he reflects about the role of central banks today. He’s the only central banker who would like to limit the power of central banks.

Kate: So, Sir Paul, what prompted you to write this book in the first place?

Paul Tucker: Two things, and they came together. The first was, I was intimately involved, and that’s understatement probably, in designing the powers that were granted to the Bank of England after the financial crisis. It became a much more powerful institution. But actually, we leant against, I leant against some powers that some people wanted to give us. We argued for careful constraints around the new powers that we were given: supervisory powers, regulatory powers, all sorts of things.

In the back of our mind was a desire not to be too powerful, to be legitimate. I wanted an opportunity to write down what lay behind that, which was things like the values of democracy, and the rule of law, and constitutionalism. Not the kind of things that feature in discussions about central banking, but I absolutely promise were in my mind, and I think in Mervyn King’s mind, the then governor, as we navigated all of that.

The second thing was the kind of ... This came to me really while I was writing the book, I started writing the book in 2014, is the debate about technocracy versus populism. I just ended up believing that technocracy needed to retreat a bit, both for its own sake, and, actually, because there was a risk of people saying, “Well, too much, too much is in these unelected hands.”

The book in some senses is about central banking, because central bankers are so powerful today. I was lucky enough, privileged enough to have some of those powers. But it is also, I don’t think of it as a book that’s about economic policy. I think of it as a book that is about democracy, and power, and populism. But not one of the books that attacks populism, or attacks technocracy. But it’s about technocracy from the inside, and where would one technocrat take technocracy? Well, shrink it a bit.

Luigi: In your book, Unelected Power, you make some very interesting remarks and comparisons with the judiciary and the military. One of my favorite lines issued by Clemenceau, who was prime minister in France during World War I, is that, “War is too serious a matter to let generals run it.” Can you say the same thing about central banks?

Paul Tucker: Not quite, but I think that’s exactly the right way of thinking about it. I should’ve used that quote in the book. The reason you can’t ... it’s not just that you can’t leave war to generals, the generals can turn on you. Finding a place for the military in our societies was a huge thing for centuries, because they are capable of taking over. They have in some countries. One of the great achievements of our societies is avoiding that.

Where this matters for central bankers is when you get absolutely to the edge of their powers, but they could still save the world. They could still make things better. But you haven’t provided for it in law. Or if it is provided for in law, no one ever remotely contemplated it. Let me give you an example. The European Central Bank saved the euro area in 2012, and it acted within its legal powers. The constitutional court later determined that. But it certainly acted in a way that no one ever had thought it could.

I think they did consult the German government. I think they should’ve gone to the Council of Ministers, which is essentially the governing body of the EU—in intergovernmental mode, there’s an important constitutional nuance there—and said, “Do you want us to rescue your project, your country, your jurisdiction,” rather than just assume it? That may sound like a formal thing, but it amounts to ... it’s consistent with our values that the unelected people should not take over. I certainly ... you can’t have central banks going beyond their legal boundaries. If they reach their legal boundaries, then it’s over to the legislature. It’s over to the fiscal people.

That might sometimes ... when I say this in this country, sometimes people will say to me, “But then the people would’ve been worse off. Of course, the Fed should always come to the rescue, and they’re going to get criticized.” I understand that sentiment. But there’s a trade-off between welfare today, and whether people accept the system of government. This is a judgment. The judgment about what to do when you’re at the boundaries, those judgments must be made by elected people, not by unelected people.

Luigi: The mood today is exactly in the opposite direction. You certainly belong to the group of people called experts. There is an increasing tendency of experts to say, “You should let us do our job, because you people don’t understand what you’re doing.” Certainly, a lot of people don’t understand what central banks and bankers do. “You people don’t understand what we’re doing, so we need to operate without the constraint of you politicians who don’t understand what we’re doing.”

Paul Tucker: I mean, what you say is true, but it’s not the whole truth. There are other people that say, “Well, we’ve had enough of being ruled over by people that we didn’t vote for, and can’t vote out.” We live, around the western world, in complex times. I absolutely don’t just mean since the presidential election here, or the referendum in the UK, and the various elections in continental Europe.

Part of the reason people are ... Let me put it this way. The more and more we put into the hands of so-called technocratic experts, the more we take a risk that there will be a backlash. So, I deliberately put it just through the voice of the technocracy itself. Part of my message would be, the technocracy needs to retreat a bit, if only out of self-interest.

Now, I actually think there’s a deeper principled reason for retreating as well, but if only out of self-interest, technocracy ought to back off a bit, and not claim that it has the answer to every set of questions, because it doesn’t.

Kate: All right, so I’m pretty sure ... I’m 100 percent positive that I am the lowest common denominator amongst the three of us when it comes to knowledge of what central banks do. So, I’m going to start out with my impression of what the Fed does. Okay? It’s as follows. It sets monetary policy. By that I mean it adjusts interest rates so that if, say, employment is low, and prices are low, or inflation is low, then the Fed will cut interest rates, so that it’s less attractive to save, people will go out and spend more, and that will boost the economy, therefore raising employment.

The opposite may also be true. If there’s high inflation and also high employment, the Fed may raise interest rates, and people will therefore cut back on their spending, and hopefully bring inflation down. Is that a fair characterization of monetary policy?

Paul Tucker: Yes, but it’s quite a few steps down the road of what a central bank is. A central bank is an institution of the state of government that issues money. It’s a special kind of money. It’s the money that we pay our taxes with, ultimately. It is the money that people are obliged to accept in settlement of payment for the goods and services that we buy, consume, et cetera.

This is an extraordinary thing. The state creates this money, and it says, “We will give this money a special legal underpinning.” If you and I ... if I bought something from you, you and I would settle, not in that money probably, certainly if it was a large amount. We would settle. There’d be a transfer from a deposit, my deposit account with a commercial bank, to a deposit account with your commercial bank. But those banks would settle amongst themselves in the money of the Federal Reserve. Once you’ve created this money, you have to decide how much of it to have out there in the economy, or what price to put on it. That’s where what you say comes in.

Luigi: But Paul, you said correctly that most of us do not transact with that money. We transact with deposits. Why in the 21st century, and there are, of course, a lot of reasons in the 18th and 19th century, but why in the 21st century do we actually let banks be in control of the creation of most of the money? Today when I deposit my money in the bank, I get zero percent. When my bank deposits at the Fed, it gets an interest. Why do they have access to an interest and I don’t?

Paul Tucker: I think this is a great question. I think there is a good answer. Imagine that we all, all the population, had accounts with the Federal Reserve in this country, with the Bank of England in the UK, with the European Central Bank in continental Europe. We would hold balances with it. I want to suggest that if that was the case, that as well as being depositors with the central bank, when times got hard we would expect to be able to borrow from the central bank as well. We would want an overdraft account from the central bank.

It seems to me the most important thing in political sense that commercial banking does, is it gets the state out of determining the allocation of credit, who gets loans, and who doesn’t. Now it may well be with the new technology that there will be a way of solving for us all being able to hold money issued by the Federal Reserve, without having accounts at the Federal Reserve, which could be used to borrow from the Federal Reserve. But I would be very nervous about what started off as a monetary initiative ending up as a credit initiative. There’s a long history in this country, by the way, of people wanting to change the monetary system, and then when politicians get a hold of it, actually turning it into a policy about credit and lending.

Luigi: Why not use prices to allocate a given quantity? I think that if the deposits are safely at the Fed, and … you can then decide on where to invest them based on prices.

Paul Tucker: This is a model which is trying to separate the monetary system from the capital markets essentially.

Luigi: Yeah—

Paul Tucker: No, no. That might work eventually. But so long as you find small businesses, or people who can’t access the capital markets, which is how things have been through the 20th and first part of the 21st century, then you will have some kind of banking-type institution, public or private, I prefer private, that makes loans to them. I think if we all have accounts with the Federal Reserve, the next stage, it

wouldn’t happen in the first week ... over the years, as decades passed, people would say, “Well, actually, the Federal Reserve should get into lending to parts of the economy as well.” Be careful what you wish for.

Kate: All right, so in addition to what we’ve been talking about, the Fed also has other roles, though. Right? I mean, we’ve mentioned private banking. The Fed monitors, and, to some extent, does have control over private banks.

Paul Tucker: What I think central banks should be doing is ensuring the resilience of the biggest banks. Resilience comes in two forms, actually. For small or medium-sized banks, if they fail, the deposit insurer pays out to the insured depositors, regular people. That’s fine. I don’t think anyone should be in the business of trying to ensure that small or medium-sized banks are so safe that they never fail.

Now, actually, everybody made the mistake of hoping that the biggest banks would never fail. That, of course, wasn’t true. They did fail, so we can’t rely, even for the biggest banks, on supervision, the Federal Reserve, people in Europe, doing this so well, and the banks being so well managed that they will never fail. That failure will happen again. We need to ensure that that can happen in a more or less orderly way, so that the politicians aren’t faced with a stark choice between fiscal bailout of the banks, and the bankers, and the bondholders, and the equity holders in the banks on the one hand, or, on the other hand, complete chaos.

Kate: But now I’m a little confused, because who is the lender of last resort? Is it the Fed, or the FDIC?

Paul Tucker: Yeah, sorry. The debate about these issues in the United States isn’t terribly good. That’s because somehow the perception has grown over the years that the central bank, the Federal Reserve, is a lender of last resort, is a bailout facility. It’s not. You should only use the lender of last resort, creating money and providing liquidity, to a bank that has got liquidity problems, but not to a bank that has got deep, deep solvency problems.

Now, of course, in a world where you can’t resolve a failed bank, a fundamentally bust bank in an orderly way, the lender of last resort and their political counterparts in the administration and Congress get tempted to reinvent themselves as a bailout mechanism. Actually, the Dodd-Frank Act, and the work the FDIC has done with others around the world kind of protects the Federal Reserve from that temptation in the future. So, the Fed is the lender of last resort, but the FDIC enables the Federal Reserve to stick to its mission, and not get into the fiscal business of bailing out banks.

Luigi: We are approaching the 10-year anniversary of the famous Lehman weekend. Even today, we’re discussing whether Lehman was solvent or insolvent. Had you been chairman of the Fed, would you have lent to Lehman, and what would your policy suggest in that case?

Paul Tucker: With today’s powers, you’d put Lehman into resolution. It would go through ... For listeners that are familiar with the jargon of the Dodd-Frank Act, Lehman would today, I hope, go through what is called Title II resolution. What would happen is that the equity holders would be wiped out, consistent with capitalism and market economy. The bondholders would take a big hit, with part of their investment converted into equity. The authorities now have the powers to do that, and—

Kate: I’m so excited to be talking about bankruptcy on the podcast for once.

Paul Tucker: Bankruptcy, good mechanisms for handling bankruptcy, are completely integral to a successful market economy, capitalism.

Kate: I couldn’t agree more.

Paul Tucker: If someone said to me, and I think I’m on the record when I was in office saying this, if someone said to me, “If you could lift one thing from the United States’ economic policies and institutions, and take it into Europe,” it would be the Chapter 11 bankruptcy procedures that you’ve had in this country, and have served you very well, because it allows failure. We’re talking now about nonfinancial companies. It allows failure to happen without the earth quaking, and that’s a kind of ... capitalism is about success and failure, and somehow getting to good places in slow motion.

Kate: Paul, I said that because I do research on Chapter 11, so I’m always trying to give it a plug.

Paul Tucker: I didn’t know that.

Kate: In any case, how would you have resolved Lehman if Dodd-Frank hadn’t existed?

Paul Tucker: Hadn’t existed—

Kate: Since it didn’t—

Paul Tucker: I’m not going to answer that question, because I wasn’t there. I mean, you have to be ... I’m not going to rerun history when I wasn’t in the room, and I didn’t have the information. I mean, it’s well known that the UK regulator, speaking loosely, didn’t permit one of the UK banks to buy Lehman. The reason for that, broadly speaking, was because the UK authorities weren’t convinced that Lehman wouldn’t bring down the combined entity, and transferring a problem from the United States to the United Kingdom.

I think that the central banks need to articulate and publish how they would go about assessing fundamental solvency in a crisis, rapidly. When I first said this to my old tribe, my old community, the response from many, not all, the response from many was, “This is going to be almost impossible. All these things happen very quickly. It has to be improvised.”

Well, I can remember when monetary policy used to be improvised. Now, your listeners might be slightly surprised, the monetary policy process that the Federal Reserve, or the ECB, or the Bank of England, it’s like a General Motors, Ford, factory production process, with the hands doing the work, typically got PhDs or master’s degrees in economics. But they are part of a very structured process that is repeated again and again, because it happens every six weeks. It’s a lot of resources as well. I see absolutely no reason why the same kind of structure couldn’t be put in place.

Luigi: Why has so little attention been put into this so-important topic?

Paul Tucker: I don’t have a complete explanation for that. I think partly because during the 1990s and into the 2000s, people started to identify central banking just with monetary policy, and with a certain type of academic macroeconomics. Also, because there hadn’t been a need in the advanced world for the lender of last resort to act as the lender of last resort for a long time. Except that even what I just said isn’t completely true. I deliberately misspoke, because it had been used in Japan.

One of the things that I think is inexplicable, and doesn’t shine a happy light on North America or Europe, including Britain, is central banks had been acting as lender of last resort in emerging-market countries, and even in Japan, but somehow that was because of something special about those countries. It couldn’t possibly happen to us. Then it did. Of course, one of the great lessons is that anything that can happen eventually will, and you should prepare for the big things.

Kate: One of the functions of the Fed is to oversee financial stability. You’ve mostly been characterizing that as, at least how I interpret it, their lender of last resort functions. But actually, it seems to me, overseeing financial stability is a much broader mandate. In some sense, what we should be worried about is the power of the Fed beyond just their lender of last resort responsibilities. Do you think that those are areas we should be worried about?

Paul Tucker: You’re right. I mean, the lender of last resort function, and the parallel FDIC resolution function, is for when things have gone wrong. But you also need policies to reduce the probability of them going wrong. That’s the regulatory and supervisory function of the Federal Reserve. There’s something big going on here, particularly with regulation. In that, what does a regulator do? A regulator issues rules that certain people or businesses are obliged to obey, and can be punished if they don’t.

Although everyone talks about the biggest thing the Federal Reserve does is monetary policy, and it is a very big thing to do, it’s a very big thing for anybody who isn’t elected to issue legally binding rules, which can be enforced with the coercive power of the state. Where that takes me, and what I argue in the book, is that for an institution that’s insulated from day-to-day swirl of politics, in my view, the function of the Fed or the Bank of England, ECB in this area, should be just to ensure that the banking system is resilient: there will be boom and bust, but when the bust comes, the financial system doesn’t collapse, and that it can continue to carry on providing the core services of payments, so we can go shopping, and credit, so that we can invest, and insurance, and risk transfer.

Then you say, “Well, how resilient should the financial system be?” You say, “Well, actually, that’s a job where you need to involve Congress, because the more resilient you make the system, maybe there is a trade-off with long-term growth.” The truth is that no one knows.

My own view is that the US financial system is quite a lot more resilient than it was a decade ago, but should be more resilient still. But I actually think that ultimately that judgment should be made by people who are elected. Then the Fed and others should get on with the job of implementing it.

Luigi: I don’t know in Britain, but in the United States, the perception is that Congressmen are not that sophisticated to make many of these decisions. How do you answer that kind of criticism?

Paul Tucker: I’ve heard this for years, but whenever I have conversations with people in government here about that, the time horizon tends to be, “We couldn’t persuade them now,” or, “We couldn’t persuade them this year.” Well, of course, that’s true. But what about over five years, or 10 years, or 20 years? These are big issues. A curiosity, by the way, of the United States, is the way the Fed is referred to as the Greenspan Fed, the Volcker Fed, the Bernanke Fed, the Yellen Fed. I mean, in a sense, those are just words that don’t matter, but I’ve worried slightly that the institution doesn’t have a long enough horizon about the deep institutional ... I mean, it’s a terrific organization at dealing with policies used today. But somehow persuading Congress of certain things, you need to have a timeline of 10 years or 20 years, so you won’t finish the work yourself. You need to hand it on to your successors. That’s what it is to be an institution, the orders passing through.

Luigi: To what extent, the resentment that is widespread, particularly in the United States, is a reflection of a sense, as you indicate in your book, that you can’t get rid of some of those people? That many of the decisions that matter for our lives are not taken by elected officials, and we cannot get rid of them?

Paul Tucker: Part of it is historical here, because there wasn’t a Federal Reserve. There were great debates about the First Bank of the United States, and the Second Bank of the United States. But I think there are two other sources of broad concern that come and go. One is this business of, does it bail out Wall Street? We’ve talked about that, but it’s really, really important that when banks and dealers are fundamentally bust, that the equity holders lose money, that the bondholders lose money, that they should not be bailed out.

The third thing is, is it clear enough what they’re expected to do? We don’t live in 1950. In today’s world, it’s really important for holders of unelected power to encourage politicians to set them clear objectives. Then, if they don’t, if politicians don’t set them clear objectives, to articulate what they will be trying to do with the powers that they’ve been given. This is trying to bind yourself in, and it’s trying to make yourself comprehensible to the public. I think that the Federal Reserve chair went on television during the crisis. I mean, that was obviously an important initiative.

In Britain, the central bank governor and others we’ve had have been going on television for some years. I hope, think, carefully, not in a way that competed with the politicians.

But if you’re invisible, if you hold so much power and you’re invisible, people can be alienated by that. So, on the whole, I think, get out there and explain. Explain in as simple language as you possibly can, so—

Luigi: This is the opposite of what Greenspan was saying. Greenspan was famous to say to a journalist, “If you have understood me, I misspoke.”

Paul Tucker: Well, I can’t remember the exact context of the question, so maybe this was a question which he just didn’t want to answer at all. But if one takes it out of context, would that be a good recommendation for central bank communication? No.

Kate: Paul Tucker, author of the new book Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State. Thanks so much for being on.

Paul Tucker: It’s been a real pleasure to be here.