Central banker as risk manager

BS OPINION

What is the central banker's main job?

The question will probably draw one of these answers: To keep inflation in check by a suitable manipulation of interest rates, to maintain the external value of the currency, and to keep economic growth chugging along to the extent it is consistent with the first two objectives.

The chairman of the US Fed, Alan Greenspan, has attempted to answer the question a little differently.

Under fire from critics for guiding US money policy on the basis of gut-feel and indisciplined analysis, Mr Greenspan told a recent gathering of central bankers and Wall Street analysts that the key job of the moneyman is really 'risk management.'

While sophisticated econometric analysis and forecasting models are useful tools for central bankers, the Fed cannot just assume that these forecasts will actually pan out and set rates accordingly.

As Mr Greenspan put it, "Every model is a vastly simplified representation of the world with all its intricacies on a day-to-day basis. Our knowledge base is barely able to keep pace with the ever-increasing complexity of our global economy."

Which is why the US Fed has, occasionally, made intuitive leaps to avoid risks that may not yet be captured by economic data.

The Fed, for example, cut rates in 1998 after the Russian debt default even though the US economy was doing just fine at that point. Mr Greenspan's judgement was that the default may trigger unnecessary turmoil in the domestic and international financial markets.

Under the circumstances, a rate cut would have a calming influence. If one were to read between the lines, what Mr Greenspan is really saying is that central bankers need not be bound by rigid monetary and other targets just because nothing else seems wrong.

They have to make judgement calls, which may sometimes go off the mark. That's what happened when Mr Greenspan miscued the bond markets a few months ago by talking about taking "insurance" against deflation.

The markets saw this as an indication that he would act to bring down long-term rates through conventional and non-conventional methods. When he did neither, the bond markets crashed, and Mr Greenspan suddenly became a villain.

The markets may not like ambiguous central bankers but when global capital flows are so volatile and unpredictable, it is foolish to believe that central bankers alone must stick to very predictable ways of reacting to events.

During the Asian crisis of the late 1990s, it is a moot point whether conventional methods to halt the rupee's slide would have worked as well as Dr Bimal Jalan's more rough-and-ready efforts to kill speculation.

In July 2000, he stunned the markets by pushing up the bank rate to prevent the rupee's slide even though the tech bubble had already burst and the markets had begun sliding steadily downhill.

What Dr Jalan has been doing in India is what Mr Greenspan is currently taking flak for from critics in the US: managing the risk of market players taking adverse positions that could prove detrimental to the economy.

If one grants that markets are creatures of sentiment and sudden fancies, central bankers have to play the percentages as much as stockbrokers when it comes to figuring out the right blend of policy actions in a given set of circumstances.

When the number-crunching is over, central bankers still have to make a subjective call on what will work. The fact that they may be wrong sometimes doesn't mean they should suspend independent judgement.