Agustin Carstens on Central Banking in Emerging Markets, the Distributional Footprint of Monetary Policy, and Central Bank Digital Currency

Agustin Carstens leads the Bank for International Settlements or the BIS in his role as general manager and previously served as the governor of the Bank of Mexico. He also served as the deputy managing director of the International Monetary Fund. Agustin joins David on Macro Musings to discuss the new BIS 2021 annual report. Specifically, David and Agustin discuss the macroeconomic developments of the past year, the distributional footprint of monetary policy, the evolving role of central banking, and the outlook for central bank digital currency (CBDC).

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Agustin, welcome to the show.

Agustin Carstens: David, it's a pleasure to be with you.

Beckworth: It's great to have you on. And I followed you over the years. I came out of grad school in the early 2000s, and my first job out of grad school was with the US Department of Treasury. I was in international affairs, the Western Hemisphere division, and you were at the time the deputy managing director for the IMF. One of our jobs was to look at IMF reports, IMF programs. I was the lowest person on the chain. I would get my thoughts and work its way up to John Taylor and others.

Beckworth: So you were a constant part of the conversation in my office during that time. And you've had quite a storied career. If I have the dates correct, from 2003 to 2006 you were the deputy managing director. Is that right?

Carstens: Yes. I was the deputy managing director of the IMF.

Beckworth: And then from there you became the finance minister from 2006 to 2009, and then you led the Bank of Mexico through 2017. So you've had quite a run. I mean, you've got a lot of experience, probably a lot of really neat war stories you could tell from the frontline as things go on. So I just want to ask you a little bit about that. Maybe before we get to the war stories and some of the interesting things that you did, tell us about how you got into economics in the first place. What led you down this path that's become your career?

Carstens: Well, that's a great question. I guess there are two key events in my life that push me into economics. One is that my father was an accountant, and he wanted me to be an accountant. And I hated accounting once I saw it. I just couldn't fathom my life doing accounting. I have a lot of respect for accountants, and in my family I'm surrounded by them, but that's not for me. Now, at the same time, I like finance. I like math. And probably this in a way has been a constant in my early life and now in my career is concern about inflation. I mean, when I was growing up, Mexico suffered quite a bit of inflation.

Carstens: I remember once trying to take the train back to my house, and from early morning to the afternoon the tariff of the train went up and I had to walk many, many miles. And I started asking questions. I mean, I was a youngster. There's inflation, so what is inflation? And inflation became a topic of conversation. I mean, in the '70s and '80s we had massive inflation in Mexico that affected day-to-day life of all the Mexicans. There were scarcity of products. There were many protests. And we had the exchange devaluations. So these being very traumatic events for society as a whole, it really caught my attention, and therefore, I think that was a major aspect that led me down the path of economics and then to concentrate on macroeconomic issues and more particularly monetary issues.

Beckworth: Okay. Well, that's a great story. The consequences of economic policy you wanted to understand it better, and therefore, you became a part of the experience yourself as a policymaker. Now, you worked at the Bank of Mexico even before you were the deputy managing director of the IMF, if I understand correctly. Were you there during the crisis of '94?

Carstens: Yeah. I mean, I'm an old horse. I started working in Bank of Mexico in 1980. I still was in college. So I lived through the crisis in 1982, major crisis in Mexico where we ended up with exchange controls, what was called then the lost decade for Latin America in the '80s. Then we had the Brady debt renegotiation that I had the privilege to participate in. I mean, I think from 1980 I started and I took a few years off to do my PhD in the University of Chicago, came back to Bank of Mexico. So in the late '80s I was a representative of Bank of Mexico in the negotiation of the Brady plan. Then I came back to Mexico and I was in Bank of Mexico since 1990 on. So I experience in real life the 1994 Tequila Crisis. I was in the trenches as we would say.

Beckworth: Some sleepless nights I imagine for you at the central bank.

Carstens: Absolutely. They were horrible.

Beckworth: So you had the Tequila Crisis in '94. Then there was the emerging market crisis in '97, '98, which also I'm sure gave you sleepless nights. It's interesting. I just got to throw this in there. So when I was at the US Treasury Department, my first job out of grad school, in my portfolio was Mexico. I covered Mexico. It was 2003, 2004, around there. And by that time Mexico was a great country, I mean, in terms of economic stability relative to the other countries in the Western Hemisphere other than Canada. So I had Mexico. And then you mentioned the Brady Bonds. I saw the last part of those Brady Bonds. I'd get memos on them and stuff, and I believe they expired around that time.

Beckworth: And the other thing I remember about Mexico during my time at Treasury, I believe it was in 2003 or 2004 when the first 10-year peso was issued, and everyone was super excited, "Hey, we got yield curve in Mexico," and it was a big deal. Just really fascinating to see these developments happen and then looking at the spreads between Mexican government bonds and US. It was really low compared to many other countries in Latin American during this time. So I had a great experience covering Mexico.

Beckworth: Let me ask you this. Given this rich experience you've had at a central bank in an emerging market, and you were also at the IMF, so you've seen from that perspective and then at the BIS. How is it different being a central banker in an emerging market than an advanced economy? And I ask that because on the show we've had disproportionately more discussion and central bankers from advanced economies, and so we hear their side of the story. So I'm interested to hear your view of what it's like to be a central banker.

Central Banking in an Emerging Market vs. an Advanced Economy

Carstens: As everything in life, there are pros and cons. The pros of being in advanced economies central banks is that pretty much everything is well-organized. The institution runs well. You're in institution that is well resourced. There is not much discussion in the country, what is the role of the central bank. There is a little bit discussion here and there about the autonomy, but by and large, the job location and the mandate of the central bank is very well ingrained in society.

Carstens: For me, I mean, through my career I would say that starting in the '80s and since the early 2000s, there was a lot of discussion about the mandate, about the role of the central bank, about the independence. Fiscal needs are constant, and therefore, there is always a lot of friction. In addition, there is also more volatility, and oftentimes volatility is related to macro instability in general in pressures on the exchange rate of inflationary pressures and even pressures on the banking system. So you really learn very early on to be a crisis fighter. I mean, I think there are very few emerging market central bank governors or executives like myself with a long career that hasn't really gone through a crisis. In a way I would say that we're more like street fighters …

Beckworth: That's awesome.

Carstens: ... in the sense that you have to face the rough times and the rough crowds, and you have to defend yourself. And I think that adds at the end of the day a lot to your ability to deal with new circumstances. So I would say that since the GFC when things have become a little bit more difficult in advanced economies, there are different aspects of those crisis, including the one related to COVID-19. It looked not exactly the same, but it looked familiar. And definitely there are some aspects of crisis fighting that we identified and we developed at the time that could pretty much be applied in a crisis in more advanced economies.

Carstens: So just living in a rougher neighborhood and having, I would say, less settled instruments tends to push you to improvise and to react more with what you have at your hand. And I think that generates a lot of very interesting knowledge and capacity that many emerging market governors have.

Beckworth: Yeah. It's interesting you mentioned the experience, the learning you go through in those crisis. You can carry through and apply it at even advanced economies who may not have all the experience with crisis. I remember in the Great Financial Crisis Paul Krugman said this is not a surprise to those of us who follow emerging market crises, what's happening. We know what's needed and the policy response. So it's an interesting point. Another question, something I picked up at Treasury, and I'm not sure if it's not true or not, but I want to get your take on this is that in advanced economies ... In my case here I follow closely the US and the Federal Reserve. When there's a temporary supply shock that lifts inflation up temporarily, we often say we need to see through it, right? Don't change policy if it's a temporary disturbance. But I often heard in an emerging market they don't have that luxury always because if they don't respond to that temporary bout of inflation, it could further erode inflationary expectation. So maybe the credibility is not there. But is that more of an issue? Is it a real issue in some emerging economies?

Carstens: Well, I would have to say that 20 years ago, 15 years ago that probably was the usual policy response, the one you described. I mean, normally what was the cause of inflation you had to basically send a strong signal that you were minding it and you would tend to tighten policy, but we all know that that probably is not the best policy response because then monetary policy becomes very procyclical. So it took some years, decades I would say even in some cases where once the central bank ... Mostly when central banks adopted inflation targeting, and that required a very good dialogue between the central bank and the economy and society, is when many central banks with credibility starting to explain what a supply shock is, why is it transitory, what usually is a change in relative prices. And the last thing you want is for the central bank to be procyclical under those circumstances.

Carstens: At the end of the day it doesn't make sense to try to reduce a price of many other goods just to face the increase of a few prices. So I think that that was an evolution in emerging markets. And many I think now can have the luxury of looking through some of these shocks.

Beckworth: Okay. One last question about central bank and then we'll move to the annual report, but I have to ask this. Hélène Rey came up with this finding in her research about a global financial cycle tied to the Fed, tied to the dollar. And some others have called it a global dollar cycle like Arvind Krishnamurthy and others. So when you heard this you were like, "Obviously, this is what I've seen firsthand as a central bank governor." I mean, did that idea really resonate with you when it was presented this idea of a global financial cycle?

Carstens: Definitely. I mean, I think what Hélène and others did was to really conceptualize the whole idea in a very accurate way, incorporate it in models and get some useful insights. But yes, I mean, it's something that we have been living with, especially I would say after the Brady Bonds in emerging markets. Once a lot of flows became securitized and capital accounts were open, and therefore, many emerging markets became far more subject to the developments in global financial conditions. And at some point there are different motivations. Obviously the monetary policy of the main advanced central banks usually play a tremendous role, but also the risk-on, risk-off effects. And also, it has been very interesting to see how through time the way these flows are intermediated makes such a big difference because that also becomes part of the whole equation, how investors participate in the markets and what are the issues that they respond to. So yes, I mean, I fully subscribed it. As a matter fact, we're doing a lot of work at the BIS on that particular issue.

Beckworth: Yeah. I really appreciate your work there on all the global dollar funding going on, and you keep track of the amount of dollar denominated debt outside the US. It's really been fascinating to follow, and some of your colleagues are doing great work there. All right, let's move to your annual report. And this is from the Bank for International Settlements. And maybe before we get to the report, maybe just quickly summarize what the BIS is, what it does. Most or our listeners already know, but for those who don't, what is the BIS?

What is the Bank for International Settlements?

Carstens: Well, basically it's a bank where our shareholders are the main central banks of the world, 63 members. They bought 17 out of the key central banks. The chairman of the board is Jens Weidmann from the Bundesbank. The chairman of the main economic consultative group is Chairman Powell. So that gives you an idea of the people who are involved here. This is the oldest international financial institution. We're 91-years-old. We were created in 1930. It started really small, not necessarily as a global institution, more like an European response to First World War where were reparations payments, Germany, France, Italy, Switzerland, England, and Belgium.

Carstens: Then that issue was overcome. And this became a first more European institution. And then around the Second World War it opened up pretty much to the key advanced economy central banks and since the mid '90s to emerging markets. And I would say that there are three key roles that we play. One role [the BIS plays] is that we are the center for coordination and collaboration among central banks. The board and pretty much all the members get together on a bi-monthly basis. I don't think that in any other field of government there are so many reunions and so much dialogue among the members. The idea is to try to enhance communication, build trust and be able to do the best we can in terms of assuring a stable financial environment.

One role [the BIS plays] is that we are the center for coordination and collaboration among central banks...The idea is to try to enhance communication, build trust and be able to do the best we can in terms of assuring a stable financial environment.

Carstens: Many of the key supervisory regulatory principles that are followed in the world are crafted here under the Basel Committee on Banking Supervision. All the regulatory agencies sit here in Basel. The FSB is hosted by us. So a lot of hands-on aspects take place here and a lot emanate from these meetings where coordination and cooperation is tried to be established. The other is that we always have been a bank that helps central banks in managing some of their assets, mostly their international reserves. We have a very broad operation helping central banks manage their international reserves, sometimes provide them some credit, but that's less than management of their assets.

Carstens: And I would say a third new role that we have been playing in the last three years or so is central banks decided that we needed to be at the top of the discussion on technology and innovation. And so we have created the BIS Innovation Hub. It's basically an effort of all the central banks to keep in line with developments in technology that is affecting monetary systems and financial systems. We have geographically distributed a number of centers in Asia, in Europe and very soon in the Americas. And so we here with this we want to be at the forefront of innovation and apply innovation to the work that in technical advance in digitization basically in all that has to do with central banking and with financial markets. So I would say that's what we do here at the BIS.

Beckworth: So, a very important institution and key to helping us maintain financial stability. So we appreciate the work that you do. All right, so let's jump into your annual report. It's out, and your first chapter is basically the year in review and the outlook. So maybe you can summarize for us what the key findings are from that chapter.

Summarizing the BIS Annual Report

Carstens: Absolutely. Well, of course, we start by saying that today we found ourselves probably in a better position that we anticipated a year ago. I think that recovery has been very accelerated, mostly led by the two big economies in the world, China and the US, but also thank to the development of the vaccination and by relatively quick roll-out of it. I think also that what has been of the essence, and I think here is where we spent a lot of time on, is on discussing the results and an assessment of the efficacy of the unprecedented macro policy response, both on the monetary side but also on the fiscal side. And I would say in comparison with the GFC what really makes a big difference is the tremendous fiscal stimulus that accompanied monetary policy in most latitudes.

Carstens: So in a way, first, there is the acknowledgement that the policy response was adequate, that they were doing, I would say, fair to say better than what we anticipated. But then there are some provisos, as always. This is not a homogenous recovery. There is heterogeneity, in particular, among emerging markets in less developed countries, also among some advanced economies. The differences are, of course, in the vaccination process and availability of vaccines, but also the policy space. The amount of capacity that the different countries, the different points in time had to really mitigate the impact of this self-inflicted recession related to COVID-19.

This is not a homogenous recovery. There is heterogeneity, in particular, among emerging markets in less developed countries, also among some advanced economies. The differences are, of course, in the vaccination process and availability of vaccines, but also the policy space.

Carstens: I mean, the policy response from a health point of view was containing it by isolation, imposing limitations to mobility, basically put the economy in a suspended animation. And meanwhile, the objective was to mitigate the impact to fiscal and monetary policies. So this was successful, but again, the capacity among countries was very, very different. At that time last year we were organizing. I would say what you could call the evolution of this crisis in first liquidity stage and then at solvency stage. The first year would be about liquidity. Therefore, also, a lot of the policy response had to be oriented towards providing liquidity, immediate liquidity and to provide massive breaches so that many firms and households would not become bankrupt to this sudden shock. But then as the crisis evolved and the need to become more selective in other, the next would materialize and that would be in terms of solvency issues.

Carstens: Now, what we report in this chapter one of the annual economic report is that we haven't seen many bankruptcies, and to some extent that surprised us. We have seen less bankruptcies than what you would even have anticipated without the shock. So the question is: why? Of course, that has to with the huge accommodation. So the question is what will happen next. What we try not to enter into a process precise forecasting, but more than anything to delineate some scenarios as we move forward and what would be the policy changes then. The central scenario is that the recovery continues, that as time passes it will be more widely spread, but some tensions could start appearing. Obviously, we are anticipating higher inflation than the objective of most advanced central banks, but the central scenario is not to go overboard. This is similar to this question we had about the supply shocks, relative price changes, base effects. Still, that could generate some volatility in the markets in particular even the differences between inflationary expectations or between what the markets are expecting and what the authorities are trying to do. But by and large, this would be a continuation of the good news with some differentiation.

Carstens: Differentiation would become more obvious also as the normalization process kicks in. Some emerging markets, for example, for reasons that we also already discussed to some extent have needed to tighten monetary policy already, and they didn't have so much fiscal space. But by and large, this will be a continuation of the recovery with some additional differentiation. The other scenario would be one in which inflation really accelerates more than what we all anticipate right now. That would require tighter monetary conditions. It's very likely that is due to a very strong recovery. So in a way it would not be a result of lack of economic activity, but that would probably require tighter monetary conditions around the globe, and that could generate more trouble to some emerging market economies.

What we report in this chapter one of the annual economic report is that we haven't seen many bankruptcies, and to some extent that surprised us. We have seen less bankruptcies than what you would even have anticipated without the shock. So the question is: why?

Carstens: Emerging market economies both at the sovereign level and the corporate level they have higher debt levels. They still are strong, and I think they have buffers, but needless to say, much tougher global financial conditions would require for them to have a more defensive attitude and probably use more of their arsenal to stabilize. That probably would also make that recovery becomes less agile and probably more differences would show up. Then there's the negative scenario, those who we cannot rule out. And that is that we don't progress as anticipated in combating COVID-19. Mutations and new variants represent problems, and at some point ends up affecting growth, affecting investment and affecting solvency too. I mean, this obviously would manifest itself in lower growth and more difficulties down the road.

Carstens: This leads us to, I would say, two important discussions that we address. One is part of chapter one. It's a relationship between fiscal and monetary policy. We would like to see more normalization in both policies. The timing of this normalization will have to be gauged in a very strategic way. You don't want both to normalize at the same time, but it will make a huge difference which goes first and which goes second. I would say that both fiscal and monetary policies are important to normalize. Fiscal policy because we're at the highest levels of sovereign debt, at the lowest level of interest since many, many, many decades. So at some point the servicing cost will be important, and I think that reining in the process of increasing debt over GDP ratio is important. The fact that the economy is growing more than the interest rate is something, you cannot trust it for the long-term.

Carstens: And monetary policy will also have to mind some of the externalities that it generates, specifically for long, because it tends to generate frothiness in the markets. Down the road that can generate financial instability. So those aspects will need to be considered. Obviously, we don't want to preempt more adjustments so that the recovery is averted, but at the same time we need to hit the right timing so that some of these trade-offs do not manifest themselves at an inopportune time.

Carstens: And then in chapter two we have a very deep discussion on the relationship between income distribution and monetary policy. By and large, our claim is that, A, income and wealth distribution is not a monetary phenomena. At the same time, monetary policy can do a lot to have better income distribution if the mandates of the central bank are withheld – namely, to keep inflation under control, to reduce the severity of recessions and unemployment, and to prevent financial instability. That lays the ground for better income distribution. As a matter of fact, we document that inflation really affects majorly income distribution, the most regressive tax that there is, and I can testify to that.

We would like to see more normalization in both policies. The timing of this normalization will have to be gauged in a very strategic way. You don't want both to normalize at the same time, but it will make a huge difference which goes first and which goes second... Our claim is that, A, income and wealth distribution is not a monetary phenomena. At the same time, monetary policy can do a lot to have better income distribution if the mandates of the central bank are withheld – namely, to keep inflation under control, to reduce the severity of recessions and unemployment, and to prevent financial instability. That lays the ground for better income distribution.

Carstens: And then we see that the last decades the most severe impact on income distribution around the world has resulted from recessions and oftentimes recessions associated with financial instability. Something that has generated a lot of attention is the fact that in the GFC in the COVID-19 response the monetary policy mean low for long, and that obviously affects the price of assets. That's a traditional transmission mechanism that tends to affect wealth inequality. Now then we recognize that that is a fact for those that mean that monetary policy should not do that, and our position is that is worse if monetary policy doesn't act. So by and large, we end up saying that, yes, monetary policy authorities should try to incorporate or internalize as much as possible the impact of inequality on monetary policy and monetary policy on inequality. But, by and large, this is a phenomena that depends on structural aspects, and from a macro policy point of view, what it can have the most incidence on is a fiscal policy.

Carstens: And then the very last chapter is on CBDC. We discuss it not so much what the CBDC and so on, but more than anything here we start putting on the table some ideas that are more related on what are key aspects that we'll need to be taking into account if central banks what to implement these and these three particular ones, and we can deepen more later if you want. One is the relationship with commercial banks, the other is the aspects of data privacy and identity, and the last one is the international dimension of CBDCs. So I guess that's a 30,000 feet view of our annual economic report.

Is Nominal Income Stabilization to Credit for Fewer Bankruptcies?

Beckworth: Yeah. Very interesting, and we will provide a link to our listeners on the show page so you can find it there. Of course, you can google it very easy, the BIS annual report for this year. So there's a lot there. Let me go back and ask some questions that will help unpack some of that. I want to go back to the point you made, and it's in the report, that bankruptcies were far fewer than many expected. You also note that banks did relatively well too and surprised many. And in the report I believe you attribute that to some of the post financial crisis regulations made their balance sheets stronger. But I want to put out another hypothesis. Why are there few bankruptcies? Why have banks done so well? And I want to suggest that maybe it has to do with the fact that fiscal monetary policy really strove to stabilize incomes, nominal income. Now, I'm coming from this, Agustin, as a fan or advocate of a nominal GDP target or also called nominal income target and in particularly level target.

Yes, monetary policy authorities should try to incorporate or internalize as much as possible the impact of inequality on monetary policy and monetary policy on inequality. But, by and large, this is a phenomena that depends on structural aspects, and from a macro policy point of view, what it can have the most incidence on is a fiscal policy.

Beckworth: And one of the arguments that's made in the literature for this is that if you stabilize nominal incomes, you're going to have a much better financial stability outcome because households can meet their mortgage payments, business can meet preexisting financial obligations and such. I'm just wondering, can we look at this past year as kind of a test run or a data point that says, "Yeah, if we try to stabilize ..." And I know you mention not every country was as aggressive as the US was. Can we look at this past experience and say, "Look, if we stabilize incomes in a counter cyclical fashion, that we're going to have less financial disruption overall." Or am I reaching here?

Carstens: I mean, I certainly think that the thrust of your comment is correct. And as a matter of fact, that was the objective. There is still a step from this policy response to really moving to a framework of nominal GDP targeting. And as you know very well, that brings another set of considerations. But I think the policy response has tried to do that. I think what was unique in this case is the fact, and I think politically it's also why it could be done, is that it was the result of a manmade recession. I mean, obviously it started by a virus, but the lock downs and so on was a health response that affected everybody. And I think what was of the essence is to try to ameliorate the real consequences of this policy and to prevent a health crisis to become a financial crisis.

Carstens: So I would say that the immediate instinct was, "Let's provide a reach to a better circumstance." And how do you provide the reach? Well, through monetary policy and fiscal policy. And I think in this case what really became of the essence is more than anything fiscal policy because at the end of the day monetary policy acts to credit, and at the end of the day we don't know exactly how much losses will be here, and that is still up in the air. And for that I think fiscal is of the essence. But yes, I think in this particular case nominal income stabilization was very, very important.

Beckworth: Yeah. So I agree. It took both fiscal and monetary policy to get that response, and that itself is maybe a lesson to be learned moving forward. And it was amazing that the response did take place. Like you mentioned, that's pretty surprising. This makes you wonder what if a policy like this had happened back in 2008 in the US? Would we not have a great financial crisis? It might be a minor financial panic at best. Okay, moving along. So one other interesting thing your report brings out is that there's likely to be, at least in some places, less economic scarring because the recovery has been so robust. There's been some talk, and I've had some guests on the show talk about this, about the idea of hysteresis. And in this case it would be reverse hysteresis, right? You're going to get the economy to heal and maybe even increase potential real GDP going forward. Can we draw any conclusions about reverse hysteresis from this period, or is it too soon to know?

Carstens: Well, my take is that is too soon to know, and we need also more time to digest all the signals that are out there right now. How much is due to the fact that we are depending or not on previous parts? We have major completely unprecedented shock. And at the same time we have also completely unprecedented policy responses. So to try to associate the responses of the economy of previous parts to be more or less guided by these parts I think it's difficult. I think that we will need to have more time to really identify what the scarring is. As a matter of fact, I think that as we move forward, that's the big question, and I think still the level of uncertainty out there is huge. And I would say at least in two or three fronts.

Carstens: One of the front is that as this crisis happened or the lockdowns happening and so on and so forth, technical progress and the adoption of new ways of doing business accelerated dramatically. I mean, starting with working from home, retail sales. I mean, today every business, every bank, every central bank is really in the debate what will be the new normal in terms of space, in terms of travel. Everybody is investing in systems because virtual activities will be part of life. And this sectorial shifts will have an impact on the real economy. And once we remove accommodation, the scars will start to appear. And also, the fact of what we discussed before is the impact on corporates. Something we don't comment on this report is that we have had very few bankruptcies, but at the same time the debt in corporate increased. And the ones in which corporates increased the most is in the ones whose sales decreased the most. And that's not a very good combination.

Beckworth: Right.

Carstens: So of course, we need to see what the end result is, if the markets are going to recover or not. Some of them are hotels, some of them are cruise lines, some of them are airlines. We will see what will happen there. But that level of uncertainty is still huge. So I think the jury is still out in terms of when are we going to see scarring.

Beckworth: Yeah. I mean, I think it's fair to bring out there is so many moving parts right now it's hard to disentangle. There'll be many papers and dissertations written about this experience, for sure. But yeah, I mean, I think it's a great point you mention. There's a lot of innovation going on. Total productivity may be going out just because there was force to it. We were pulled out of our complacency. The Fed's doing a new form of ... I call it a new form of price level targeting, which is also very different, which makes things noisy. And then to have that going on and then try to tease out, well, what's reverse hysteresis doing? There's just a lot of moving parts. It's going to take a while.

Beckworth: I want to go to your next chapter, though, on the distributional footprint of monetary policy. And you already highlighted how monetary policy can actually contribute and minimize inequality. I think it was great. It's a great point. At least in the advanced economies we forget this that high inflation is a huge form of inequality generation, and I think that's a great point you bring out. And then your second point was just minimize and stabilize the economy, respond to those shocks so that we don't have ... And I get the impression that many people when they point to the Fed or the ECB for keeping rates too low for too long, in the midst of a crisis they're not doing the right counterfactual. So had the Fed not stepped in last year, where would we be? Or even going back to 2008, if the Fed hadn't done QE1 ... I think QE2 and QE3 was less effective, but QE1 the markets literally froze up. Had it not done that, maybe we would have had a great depression 2.0.

Beckworth: At least my sense is that it's important to do the right counterfactual. Yes, the Fed may help bring rates low, maybe rates were low anyways, but nonetheless, the economy might have collapsed even more severely had they not stepped in. So, do you think that's a fair point?

Distributional Footprint of Monetary Policy

Carstens: Absolutely, yes. And that's the point we make there. Now, obviously it's very difficult to make the counterfactuals. But precisely what we do in this chapter is we try to dig deeper and try to dig more evidence that what we say make sense. Something that I think there is very, very strong evidence is that taking hyperinflation or very high inflation out of the picture because I think that there is consensus that the effect on income distribution is very detrimental. What we see is that recessions with high unemployment and, in particular, when they are related to financial episodes, not necessarily financial crisis, but financial generated recessions, which, by the way, in the last decades they have become the most common ones. Those are the ones who have the strongest negative impact on income distribution.

What we see is that recessions with high unemployment and, in particular, when they are related to financial episodes...Those are the ones who have the strongest negative impact on income distribution.

Carstens: So of course, the emphasis should be trying to prevent those crises, and that's why the role of supervision and regulation becomes important, and there central banks have to contribute. But in addition to that, to limit the span and the impact of those recessions and those financial cycles helps tremendously. That's why we also decided to bring this on the table at this time because we thought that it's a discussion we need to have, and I think we need to put all the elements on the table.

Beckworth: I'm glad you did because I just feel like this is the point that's missed by many, many observers. They think it's increased inequality, but they haven't looked at what inequality would be like if the economy completely collapsed. And just to be clear in the chapter, you mentioned in that monetary policy chapter that central banks should wear their non-monetary hats effectively. That's referring to macroprudential and regulatory roles. Is that right?

Carstens: Yeah. Those are the two most abused hats that monetary authorities can wear, but there are others that are very important, for example, in terms of promoting financial inclusion. It's widely known that even in the US a large percentage of the population mostly in the lower levels of income distribution they don't have access to financial services. They don't have options to save. They cannot benefit themselves of efficient payment systems with low transaction costs. They are the ones who are affected the most by predatory lending, by pawn shops, all those phenomena that we see them out there. But they have a terrible impact on income distribution.

Carstens: Financial literacy is another aspect that becomes very important for consumer protection. And I think we need to do more in that respect. I think the consumer protection of financial services is something in many, many countries of the world there is still a lot of scope for action.

Beckworth: Let me ask one more question about this chapter and we'll move on to the central bank digital currency chapter. So the Fed does have these other hats that it wears, but it seems like it's been asked to wear more and more hats. And I worry that it may be asked to wear just too many hats and ultimately could jeopardize its independence. So for example, part of the inequality move or greening of central banking, these things are happening, but could that open up a door that would make the Fed very politicized? And so when some other party comes into power, they're going to swing the Fed in the other direction. Is there any concern about this? The central banks are doing too much. Again, these are important issues, but are they better left for fiscal policy for Congress than the central banks themselves?

Central Bank Activism

Carstens: The way I would answer this is I think that central banks have core functions, and they have instruments that are better to pursue some objectives and not others. I mean, I think at the end of the day the main instruments they have is to preserve price stability, financial stability and to help the economies to get out recessions. Now, that doesn't mean that some of the instruments or some of the policy reach cannot benefit other aspects of society. But A, many of those aspects or challenges are not monetary in essence. I mean, it's like I said that about income distribution. Therefore, fiscal policy, structure policies play more important role. Also, climate change is not a monetary phenomena.

Carstens: Now, there are some aspects of the scope of central banking where in the margin we can contribute towards improving the sustainable economy and so on and so forth. So I think if we can do that without affecting our main obligations, I don't see why central banks shouldn't do that. But I think we have to be very clear about how we're engaging in those processes, what are the limitations, what are the instruments, and also not create an image where the central banks will solve all the problems in the world.

There are some aspects of the scope of central banking where in the margin we can contribute towards improving the sustainable economy and so on and so forth. So I think if we can do that without affecting our main obligations, I don't see why central banks shouldn't do that. But I think we have to be very clear about how we're engaging in those processes, what are the limitations, what are the instruments.

Beckworth: Right. Okay. Let's move to central bank digital currency in the time we have left. We're nearing the end of show here. And you have a great chapter on it, and you've touched on it already. Let me ask this question. Why are we having this conversation about central bank digital currency? It's everywhere. The Fed's going to have a report out this summer on it. You guys have written a lot about it yourself. Is there a demand for central bank digital currency? Do you think the public wants it, or is this more like a build it and they will come, more of a supply, push it out there and people will start using it? What's driving this conversation?

Central Bank Digital Currencies

Carstens: Well, there are two or three key aspects to it. I mean, at the end of the day society wants faster immediate payments. Now, we have that already in different parts of the world. Some of them through systems provided by central banks, not by CBDC, but by systems provided by central banks. In some others by commercial enterprises. Even the ones that are provided by central banks they operate on commercial money, which at the end of the day have the support of the infrastructure of the central bank.

Carstens: But there are two dimensions at least that could make the case for CBDC. One is the fact that society at some point might want to have or to deal with payment vehicles that direct the abilities of the central bank. I mean, the ones we use with credit cards, with debit cards, checks and so on are commercial bank liabilities. And what cash brings is that is direct liability of the central bank. Many people say that cash is on the way out, which I don't believe fully, but yes, there is a tendency of reduced use of it. I mean, people might say why should I live without the option of the possibility of having liabilities issued by the central bank?

Carstens: Now, in this case what needs to be done is to produce central bank money with more technologically advanced representation, and that would be digitally. So I think this is very important deep down obligation that central banks have. And the other important aspect is that a lot of this fast payments, digital payments and so on, even though as time passes they become broader, they become easier to access, cheaper to access and so on and so forth, still, you could have distortions like, for example, the domination of some players. You might not have the conditions for all the population to have access to them at relatively low costs and so on and so forth. So from a competition point of view I think it's important that the central bank can offer this.

There are two dimensions at least that could make the case for CBDC. One is the fact that society at some point might want to have or to deal with payment vehicles that direct the abilities of the central bank...And the other important aspect is that a lot of this fast payments, digital payments and so on, even though as time passes they become broader, they become easier to access, cheaper to access and so on and so forth, still, you could have distortions like, for example, the domination of some players.

Beckworth: Okay. One last question about this, the CBDC. You have that innovation hub there at the BIS, so maybe this could tie into that. But one of the concerns I've heard, and I think it's a reasonable one at least in my view, is if central banks get into CBDC, will they have the incentives to continue innovating technologically? Banks have a proper motive to provide better and better services. Years and years ago we didn't have online banking. We got online banking. And so do you see any issues with CBDC and central banks being able to continue to innovate? Or maybe you guys will be doing that for them at your innovation hub.

Carstens: No, the way I think this is being looked at is a process that will be supported by a two tier system where the core of system is offered by the central banks, but central banks will need also the commercial banks to distribute CBDC and to deal with the retail side of it. As today, commercial banks leverage central bank money. I think the same thing could be done with CBDCs. I mean, I don't see a system where each one of us have an account with our own respective central banks, and then the central bank will have to deal with each one of us. I mean, I think that's a very tough call.

Carstens: Central banks, for example, do not want to be in the AMLC of this space. Central banks will have to provide stability to the system. It has to be very precise. It has to be cyber resilient. And I think there has to be a new relationship within the central banks and commercial banks in which the central banks provide the trust of central bank money and commercial banks and other service payment providers provide more of the innovation and more what is needed to make the final service more adequate for society at large.

Beckworth: Okay. Well, we have come to the end of our show. Our guest today has been Agustin Carstens. Agustin, thank you so much for coming on and sharing your thoughts with us.

Carstens: A real pleasure. Thank you very much for having me, David.

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