Jul 29, 2019

Ulrich Bindseil on Central Bank Operating Systems

David Beckworth Senior Research Fellow , Ulrich Bindseil

David Beckworth: Our guest today is Ulrich Bindseil. Ulrich is currently director general of the Directorate General Market Operations at the European Central Bank, in November will become director general of Market Infrastructure and Payments at the European Central Bank. Ulrich has written widely on central banking operating frameworks including a textbook, and is considered one of the world's leading authorities on operating systems. He joins us today to talk about central bank operating frameworks. Ulrich, welcome to the show.

While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu.

Ulrich Bindseil: Thank you David. Thank you for inviting me.

Beckworth: Well it's a real treat to have you on. We've read a lot of your work and you've been discussed before by some guests on the show so it's a real honor to have you on. And like I do with all my guests, I want to begin the show by asking you, how did you get into economics?

Bindseil: I got quite straight into it. When I was 17 I started to study it in a remote place called Saarbrücken that probably nobody knows in the U.S. and even in Germany people don't know it really. There was one professor then, his name was Rudolf Richter, he had written a book on theory of money which was even translated into English at Springer. And so I got into this theory of money and that brought me somehow then to central banking. When there was a vacancy notice by the Bundesbank, I think it was in 1994 that I joined central banking in the economics department of the Bundesbank.

Beckworth: So you were at the Bundesbank before the European Central Bank came into formation. So you've been at several central banks then, is that right?

Bindseil: Yeah. The '94 was exactly four years before the launch of the Euro. In '97, I moved to something called European Monetary Institute, which was preparing the ECB basically. And that brought me, I would say somehow to market operations and to operational frameworks. In the research department of Bundesbank, I had written a paper on reserve requirements and their role for economic stabilization. And then the people at the EMI were looking for someone to really develop the practical side of central banking, which is those market operations, liquidity management. And they saw my working paper and they believed that I knew those topics. I had just written a working paper. But they took me and then, practice.

Bindseil: We were in close cooperation with national central banks where the practice had been ongoing obviously. I think we were quite successful in launching the Euro very smoothly, together with national central banks in '99 was, I would say smooth market operations, and a little disturbance to money markets through some operational framework, tricks from the beginning. We had a very narrow corridor over the first two or four weeks, which we then moved larger. Just to say tweaking the operational framework was something we did from the very first days of launching the Euro.

Beckworth: You really have gotten deep into the plumbing in monetary policy. You know operational frameworks really well, and you've become one of the leading experts in the area. I want to ask about your current position. Now, you switch November 1st, but currently you're the Director General of the Directorate General Market Operations. Can you explain to our listeners what that entails?

Bindseil: Yeah. The central bank balance sheet is nothing as ... Then on the asset side, at least a set of positions that you established through financial market operations. Every central bank has a market operations department, which conducts all the operations. For example, ours is responsible to start with, although it's not the most important one, the foreign reserves of ECB. Around 50 billion of foreign reserves, small amount but still to be invested mainly in U.S. dollar. Then, traditionally we implemented monetary policy through credit operations. So every week we conduct a tender with all eligible banks who come to us who say how much money they want to borrow for one week.

Bindseil: You don't only have to conduct the operations, but you have to maintain the list of eligible counterparties, so who can come to ask for credit, and the eligible collateral set. What collateral can you bring? You have lots of practical procedures to maintain those frameworks. And then we always had also a Euro investment portfolio. I think it was around 20 billion of Euro domestic investments. And then starting in 2009 after the crisis, we started to have monetary policy outright portfolio. We purchase securities and we currently manage a stock of 2.6 trillion Euro of securities purchased in the context of QE programs.

Bindseil: We're currently not increasing this stock, but we are reinvesting it. Every month we have around 15 to 20 billion of reinvestment in different types of fixed income instruments. And the department has around 150 people. And in addition, we have a lot of coordination work with national central banks because it's all operated in a semi decentralized way, where also national central banks conduct operations and what constitutes actually the Eurosystem balance sheet, is the sum of the ECB balance sheet and the NCB balance sheet. And my department is both coordinating the whole thing, and contacting partially our own operations contributing to the overall balance sheet.

Beckworth: Yeah. Just to make this clear, maybe to the American listeners, you're the equivalent of like the New York Fed’s trading desk, is that right?

Bindseil: Yeah. It's not totally comparable because we do ... Take the example of the purchase programs, we coordinate everything. You could say it's a more decentralized system than the U.S. one because there's not only the [New York Fed] doing the operations, but there are lots of national central banks doing it. But we're also not like the Board of Governors who doesn't conduct its own operations. The ECB insisted it wants to be a central bank also doing its own operations.

Bindseil: We do around 10 percent of the actual purchases of the purchase programs. We're coordinating, but in practice we're in addition like one for the national central banks, to be able to say, “We know exactly what we talk about. We're ourselves in the business of operating in financial markets.”

Beckworth: Very interesting. It'd be the equivalent of like Simon Potter in the US telling all the regional banks, “This is how much you can go buy in the open market.” Although that's not the way it actually operates here. But that's what you would equivalently be doing. You're directing the national central banks, and doing some of your own trading as well.

Bindseil: Yeah. Something like that.

Beckworth: Okay. Now in November you're going to move over to the Director General Market Infrastructure and Payment system. Briefly tell our listeners what is that position going to be about?

Bindseil: Yeah. So as the name says, it's responsible for Euro area payment systems and market infrastructures more broadly. So security settlement system, CSDs, CCPs, in principle or market infrastructures. And there it has both, oversight and policies as well as running certain systems on our own. So the main RTGS system TARGET2 is run by the Eurosystem, and the Eurosystem also provides now a framework for CSDs called TARGET2 Securities, which allows for an integrated securities settlement in the Euro area, which we didn't have before.

Bindseil: The last thing we did was to launch an instantaneous payment system where you can on the retail level make payments within up to 10 seconds for person to person payments, et cetera. So this department has both oversight and it's safe providing infrastructures. Again, a bit like the Federal Reserve System.

Beckworth: Yeah. Exciting times at the European Central Bank. Now we just learned that Christine Lagarde is going to be moving in with you over there leading the central bank, and you got Philip Lane who gave an interesting talk recently. A lot of interesting things going on over there at the European Central Bank. And I guess I should probably let you at this point give your standard central bank disclosure.

Bindseil: Yeah. I think we get now in the substance and just to mention of course that the views will be my views not necessarily the ones of the institution for which I work.

Beckworth: Okay. And I want to motivate this discussion by going to your paper that you gave at the Kansas City's Jackson Hole Conference called the Economic Symposium, I think 2016. And your papers title was *Evaluating Monetary Policy Frameworks*. We will have a link to that on the web page for the podcast. Really great paper that looks in great detail at the operating system, operating framework issues.

Beckworth: And for our listeners, just to be clear, Ulrich also has a textbook which I've purchased and some other papers. If you really want to learn the plumbing of central banking, Ulrich has got all the goods you need. I have your textbook. I've looked at that. I've looked at some of your other papers as well. But for our conversation today, I want to base it around your 2016 paper, *Evaluating Monetary Policy Frameworks*, because that's widely accessible, it's free. People can get it. It was given at the conference in 2016. The whole backdrop of that conference was the whole framework of monetary policy. Right? Tell us a little bit about the setting where you gave the paper.

Bindseil: No, I think at the conference, it was part of what is called the academic session. I was in the middle of papers by professors from U.S. universities, my paper was the most really applied one, which really went through the practical topics. And I think because the audience largely consisted also of practitioners, they appreciated this practical perspective. The typical academic paper has to be focused on making one narrow point and making it well.

Bindseil: This paper was really giving a broad overview, not pretending to invent something very new on one specific point. And I think that was appreciated thereby in the conference. And Simon Potter was one of my discussants and he was very friendly in his comments to the paper. So there I got positive feedback. Of course this type of papers, I didn't pursue it, to shorten it, to focus it, to submit it to a journal. It stayed let's say, a practical conference paper for Jackson Hole as it is.

Beckworth: Yeah, it's a very good paper. Again, I recommend our listeners take a look at it and full disclosure, I'm someone who very much is sympathetic to a symmetric corridor system. And sadly the Fed did not follow the implications of your paper, in my opinion. There's room for disagreement on this topic, of course. But as we know and as listeners know, the Fed has stuck with its floor system and there's lots of different approaches out there and we're going to get into some of these as we talk about your paper.

Beckworth: Before we get into all that, I want to begin discussing your paper by looking at some interesting points you make at the beginning, some interesting observations. And that is that this issue has been discussed since we've had central banks. Now in my view, I got into this topic after the crisis when there was a debate at the Fed between, do they stick with the floor system, do they go to a symmetric corridor system? But you really show that this has been an ongoing debate since the beginning. Tell us a bit about that. There's always been a debate right, about how to do the operational framework.

Bindseil: No, it's a very old topic. And after writing this paper, I got even more into the history of it. And you can trace it back even if you want to the 16th century, no, to the origin of public banks offering lending facilities, through the 500 years of history you could say of operational frameworks. Even though, let's say monetary policy in the narrow sense where you influence through interest rate setting, the economy is only whatever, a hundred years old or should we even say it only starts with the paper standard even more recently.

Bindseil: But you know that a public bank playing a central role defines the framework including who has access to deposits, under what conditions loans are provided, what collateral is requested, what rates are imposed. That is a very old ... Much older than I thought myself when I wrote this 2016 paper. If I can use it to mention it here, I wrote a book in the meantime, it's called *Central Banking Before 1800: A Rehabilitation*, where I developed this topic. Okay. It's not the topic of today.

Beckworth: Very interesting. This is a very old discussion and we're not really breaking new ground. We're just going back to previous debates. And I found that interesting. I was looking at one of your papers, in fact I was looking at your introduction to central banking lecture notes, and you mentioned in there that Henry Thornton in 1802 was having this discussion and he pointed towards that central banks aligning their target interest rate with what we would today called the natural interest rate. I was surprised to see that. I hadn't seen that before. And this is long before Wicksell made his point about the natural rate. Even Thornton was discussing the operational details of central banking back in the early 1800s.

Bindseil: Yeah. You could say that's more than an operational detail, no? That the core of stabilizing prices is to steer interest rates in a way that you somehow match it with something called the natural rate. I think that's not the framework, that's the core element of the transmission mechanism. It's the basic logic of what central bankers believe still today is a core of transmission.

Beckworth: Yeah. Yeah, that's fair. It's just striking to me that these debates were happening hundreds of years ago and we're still having them today.

Bindseil: Yeah. But Thornton is really the first one. The background is why did he look into this is that UK was under paper standard there, because of Napoleon. Otherwise they had a metal standard and in a metal standard you have no leeway to set interest rates per se. But then they were under paper standard, they had acquitted convertibility and therefore they were in the context similar to the one we have today of unconvertable paper money. And he had then the clarity to see what the core of monetary policy in the paper standard would be.

Beckworth: Yes. Very interesting discussion. Let's move from the history to the points that you develop in your paper. One section looks at the consensus of operating frameworks as of 2007. And I'm going to maybe list a few of them. We'll, go through them and I'll ask you for some comments on some of them. The first one I think everyone understands the desirability of a single and well-defined operational target for day to day monetary policy implementation. I think our listeners understand that one.

Beckworth: I'll go to the second one. The best operational target is a short term interest rate. Now, that also may seem fairly reasonable to everyone, but one point that you raised in your work is that there's also been times where people would look at using the monetary base or changes in the monetary base versus changes in short term interest rate as an operational target. And my question to you is, has there ever really been a period or a sustained time where central banks have used that approach as opposed to short term interest rates?

Bindseil: I would say no, only according to some textbooks maybe, but not in reality. An operational target should be something that you can control on a day by day basis and it makes sense to control it. And the monetary base is a mix of two very different things. One is bank notes in circulation, which is really determined by payment habits and structure trends, idiosyncratic to the payment area and reserve requirements, somehow it might be a fraction of short term monetary liabilities. Completely different properties from bank notes.

Bindseil: So why would you put those two things together and try to control them? On the short term you would create huge volatility in financial markets. You'll try to stabilize something like bank notes, the sum of bank notes and something very different where there's no point in stabilizing it. I would say clear answer to your question. No, this was never done in reality.

Beckworth: And I think the answer I got from your paper and what you just said is it was just much simpler to use a short term interest rate than to try to wrestle with the monetary base?

Bindseil: Yeah. Let's say the references made to monetary base or to quantitative targets. That was done over the years in different forms and maybe the most exceptional episode was one of Volcker in the early '80s, where this was, let's say, the most far reaching attempt to suggest that really the Fed was controlling in the short term different monetary aggregates. And Volcker did a brilliant job at the end to reverse the trend of ever increasing inflation rates, and to start a trend, which is really off historical dimensions because ever since then global inflation rates have been falling. Let's say he framed the thing in a way that is probably not strictly correct in terms of what really happened, or what he [had] really done. But he did it in a brilliant way to make history, I would say. Creating a new trend which we still let's say have today.

Beckworth: Okay. We'll look at a few other points in the list. I won't go through all of them for the sake of time, but some other, I think important ones for the 2007 consensus on the operating framework for central banks around the world, the consensus had emerged by that point. You mentioned they should be simple, parsimonious. Another point you bring out, that reserve requirements were a tool for smoothing daily autonomous factors. And some central banks had completely given up reserve requirements. You mentioned Sweden, Canada, New Zealand, Australia. So tell us about that point there, reserve requirements versus daily open market operations. What was the view by 2007 on that?

Bindseil: In 2007, there was already both cases. Some central banks going for reserve requirements and averaging. The main justification given then to reserve requirements was to provide a buffer if they have to be fulfilled only on average over months or over two weeks as the Fed has it. So, that was one set of central banks. But then there was this other set, you mentioned some names which had daily operations.

Bindseil: So the daily compensation of autonomous factor shocks was done by open market operations. And I think both work. The consensus was that you can do either way and as an empirical pattern, you could say the large, large monetary areas, US, even UK then, Euro area, Japan, they all had reserve requirements with averaging, while the smaller countries let's say Australia, Canada, New Zealand, they had this narrow corridor or daily operations or reserve requirements and I wouldn't have a strong view.

Bindseil: I sense that this framework of those smaller countries is a bit more lean, a bit more ... Reserve requirements with averaging are really complex because the averaging is different on every day of the reserve maintenance period. It makes a difference if you have still 20 days to come and three days behind you or three days to come only and 20 years behind you. So every day the theoretical optimization by the banks is somewhat different, and that's quite a complexity, which I would say is not the optimal in my vision of a long term framework.

Beckworth: Let me ask this question. You mentioned that the size or the large advanced economies, large currency areas like the United States, the Eurozone, the UK, they tend to use reserve requirements for the smaller open economies, New Zealand and Australia for example, they use the open market operations. There's theoretical arguments you can make, but on a practical level, is it just because they're smaller, they're leaner, they're more efficient, they can do this easier than a bigger area can?

Bindseil: Yeah. They could be. There's purely a practical point that you make. But maybe you're right to say, they're small open economies. Maybe the reserve requirements ... Now I'm just inventing because you said it, and maybe you have a good point that if you're a small open economy, maybe you have to be able to change interest rates in the short term to intervene directly in markets. And an averaging in a certain way prevents you from doing it. If you have ECB now is six weeks averaging period, you can change interest rates in an orderly manner only at the beginning of a reserve maintenance period.

Bindseil: Otherwise you have an arbitrage issue. If within the reserve maintenance period, you know that tomorrow the rates will be increased or decreased, you have immediately front loading and strange things happening. So maybe it's a macro issue. A small open economy needs immediate ability to change interest rates. It's worth thinking about it.

Beckworth: Yeah. I just… thinking of this and it strikes me as fascinating. Some of these small open economy is also I think have an easier time hitting their targets. I'm going to, for example, point to Australia, Israel, these smaller countries, at least some of them did better during the great recession. Australia didn't really have a recession. Israel had a mild one and I've had previous guests on this show and they're like, “Well, yes David. They're small open economies. The foreign exchange channel of monetary policy works much quicker for them. Where the big economies like the U.S., the Eurozone, where like a big tank takes a long time to move to get anything done.”

Beckworth: So monetary policy is harder to do in the bigger economies. And maybe same principle applies for the operating frameworks. If you're small, you're lean, you respond quickly, you do things bigger areas cannot do. And the interesting thought that maybe at both the target and the operational levels, it's easier if you're smaller and a leaner economy.

Bindseil: Just to say something a bit opposite, our life is in large monetary areas is pretty easy now because we're ... Foreign day to day, foreign exchange flows, and so on are so relevant for us. So only-

Beckworth: True.

Bindseil: ... Of course you have ... If your currency really appreciates and you have macro implications, and that may be relevant also if you're large monetary area, but the day to day stuff you're much more relaxed now. I think the perfect practical central banker should always have an internship in a small open economy or so like a-

Beckworth: There you go. That's a great point you just raised there. Because I was thinking as I read your work, what do central bankers do? How do they learn this? How do they learn the operational details? They can read your work. But maybe they need to go visit these small open economies like you said, and get some time in there as well. Well, let's move on to another point of the 2007 consensus, which I found was interesting. And you've said that a symmetric corridor system around a target interest rate was the preferred approach for day to day control overnight interest rates. So in 2007, a symmetric corridor was understood by most central bankers, most practitioners to be the best approach. Is that right?

Bindseil: Yeah, I think that one can say, yeah. The Fed didn't have yet a symmetric corridor. It had moved one step towards it by having a discount facility which was supposed to be no longer stigmatized, and which was a hundred basis points above the Federal funds target. Right? So this upper part of the corridor they had set up, but they had never set up a deposit facility. I think because of legal restrictions, not to remunerate reserves, was not possible.

Beckworth: Yes. So I've always understood the pre-2008 system of the Fed as an asymmetric corridor system because the zero lower bound effectively was the lower part of the corridor because they hadn't set up interest and excess reserves yet. But you highlight in your paper there's different kinds of asymmetric corridor systems, which I hadn't thought about. Not just one asymmetric corridor system, there can be multiple versions of it. But it's interesting, nonetheless, to me that we had a consensus in 2007 that a symmetric corridor approach is probably the best way to go.

Beckworth: And countries were converging toward that. And then of course the Great Recession comes, the financial crisis, and now we have a hodgepodge of different approaches going on, which is a nice segue into the next points that you raised in your paper. What are some of the big lessons from the past decade, during the crisis, coming out of it? What have central bankers learned? And you've mentioned several items. One, central banks need to be able to quickly respond to the crisis. Their operating systems need to be robust, be able to quickly respond to the next emergency should it arise.

Beckworth: And this just made me think, maybe central banks needed to have their own stress tests. Like in the US here, we do stress testing of commercial banks. And maybe this happens already, maybe I'm behind here, but do central banks and their operating departments, do they game it? Do they have scenarios they play? What if we had to go out and do a massive large scale asset purchase? What if we had to add liquidity to the system? Is that something that happens?

Bindseil: Sorry, you mean to be prepared, what do we need to have?

Beckworth: Yeah. Is there something like a stress test that central bankers do to themselves to make sure they're prepared for the next crisis?

Bindseil: In the Euro area, we fear that we're still ... We didn't have a long year break since the last crisis. We still-

Beckworth: Still working on the last one. Yeah.

Bindseil: Where we started to think ... as you say, "Should we have a stock take of all the lessons we learn that future generations then can take them out of the draw and be quickly prepared?" But we quickly forgot because we moved from one challenge to the other. We had almost 10 years of uninterrupted emergency liquidity assistance to banks. I think it just stopped three, four months ago, where the last Greek Bank had repaid emergency liquidity assistance. We're massively still invested into outright purchase programs in various asset classes. We have more than 200 billion of corporate bonds portfolio, which over the years the average rating would not become better, but worse, naturally. I would say we have stress banks, we have everything. We're remote to the worry to lose knowledge about facing difficult financial markets.

Beckworth: Sure.

Bindseil: It's our main worry, really.

Beckworth: Yeah, that's fair. That's a fair point. You guys are still dealing with lots of other issues, still in the midst of the Eurozone situation and in fairness to the Fed as well. The Fed just this year decided to make the transition to the floor system permanent. They're still learning the ropes and there's been a lot of tweaking of the Fed's floor system. So there is maybe a lot of learning and dealing with post-crisis situations going on.

Beckworth: That's a fair point. Maybe it's an unfair comparison to commercial banks having stress tests. But you may raise again that point, it's important to maintain the human capital that is formed during this past decade. It's important to have people there who understand operating frameworks, who know how to make them work and respond to crisis. Is that an issue, of losing these individuals?

Bindseil: Yeah, I think that's always an issue. In central banks, there's a bit this dichotomy between academic economists coming in and practitioners. And ideally those two people inspire each other, work together, build human capital combining the two and that should be maintained. And I think mobility between departments is important. And yeah, maybe there some people write articles, books about their crisis experiences is good. Then I think we will be fine, we will be fine. And the decision makers of course need understanding. If you have a mixture in your decision making parties between practitioners and people from all sorts of origins, that's important as well.

Beckworth: Yes. Okay. Let's move to principles for evaluating operating frameworks. And you've got a great chart. It's figure one in your paper where you group nine different principles under three broad categories, how do they fit into monetary policy, financial and fundamental? And I encourage our listeners to take a look at that chart. But you go through and you valuate operating frameworks based on the number of these principles. And for the sake of time I can't go through all of them.

Beckworth: But I do want to go through a couple of them or several of them and ask you about them because these were very interesting points I hadn't seen before. One of them was automation. So in there you discussed the importance of automation and you say this, “Compared to macroeconomics, monetary policy and implementation in advanced large monetary areas does not appear so complex that it could not at least to a large extent be rules based.” So can you explain that?

Bindseil: Yeah. You can give, to start with, negative examples of where central banks overloaded implementation with elements which are complex and not necessary. One example is from the '90s, I think that was a phase where the Bundesbank did it, where you signal your future monetary policy decisions by already providing a bit more liquidity and credit open market operations so that the margin rate in some auction starts moving in the direction. So then you make markets up serve every operation and try to extract policy content from it.

Bindseil: And in terms of governance, it's very complicated because some decision-makers have to decide every week, how much information they want to load into the weekly credit operation. That's one example. Another example from the early years of ECB was variable rate tender with minimum bid rate where every week, you then discuss depending on the amount of bids that you have received, whether you give one billion more, do you give 56 billion or 57 billion, impacting on the marginal rate of the operation by one basis point?

Bindseil: And there's a committee discussing each time. Should it be one billion more or less? I think that cannot be. There must be an ex ante framework - logic that you can define in advance where the bids that you receive in a tender are mapped automatically into a tender result that makes it more transparent to banks. And you save time and unnecessary discussions within the central bank. So, that's two examples where you make things complicated, which don't need to be complicated. And my vision of an automated framework is one where you have regular credit operations, but where the tender itself is a mechanical. And there are two ways to do it, you can offer a weekly operation with what we call fixed rate full allotment.

Bindseil: The banks come, say how much they want at the rate that you specify in advance, and then they get what they were asked for. So there's no complex decision making. And the alternative is that the central bank sets the volume, says, “My forecast of bank notes and of all other factors tell me that a neutral liquidity amount is 8.5 billion.” That's the mechanical calculus that you do. There's no policy content. And then you say, “Here's 8.5 billion, post your bids.” And you have the variable rate tender, and auction where the cutoff rate is simply the intersection between this vertical supply curve and the demand curve and that's it. So let's say no policy discussion on a regular basis in the conduct of monetary policy, or the policy discussion takes place at the meetings of the policy making committee, like the FOMC in the U.S.

Beckworth: It's very interesting. I hadn't thought about rules based approach to the operating framework. I had as most macroeconomists have, thought about it in terms of policy itself. So, does a central bank follow a Taylor rule, for example? That kind of discussion. There's a debate about that, how much discretion? How much rules-based for macroeconomic policy? But this is really interesting to think about this same idea, rules-based approach for the implementation of monetary policy. Another interesting insight, I encourage our listeners to take a look at that.

Beckworth: Another point I want to move to in your discussion for your criteria for evaluating operating frameworks is the financial neutrality point. And you outlined two different views about how central bank implementation, its balance sheet can be neutral. And these two views come to very different conclusions while both claiming to promote neutrality. One is the central bank independent view. And the other is the consolidated balance sheet view. Now the central bank independent view, you call that the German view. And if I understand correctly, that view says, “The central banks should be like the average investor. It shouldn't overweight government securities in its portfolio. Therefore it should have a mix of all kinds of securities.” Is that right?

Bindseil: Exactly. Yeah. It's to say ... It comes from the angle that any privileged treatment of the government in any form is not good for the central bank. Because of history, I guess it's inspired by the hyperinflation, by monetary financing in the early '20s and so on. You're not more favorable to the government and you could say, "Yeah, this is neutral." Because you minimize your impact on relative prices between government and private dept. If you treat them similarly and replicate in your collateral and maybe outright securities portfolios, if you replicate market capitalization across those issuers, you're neutral to spreads, and that's good, that's how you should do it.

Beckworth: It's interesting. This view says, "Look, the central bank should be similar to the average investor, don't overweight government securities." Therefore that would be the neutral approach. The other view says, "Hold on, we also have a neutral view," and the idea here is to have a lean consolidated balance sheet, which implies the central bank should have more government securities because if the central bank has more government securities, you combine the central bank's balance sheet with the treasury's balance sheet and they offset each other. And that implies a smaller footprint for the consolidated government balance sheet, and that's more neutral. So, that's a fascinating view as well.

Bindseil: You summarized it perfectly, that's also legitimate. You can follow this logic. You say, "The central bank is part of the state sector, so why do you want to artificially lengthen the state balance sheet?" They should be viewed in a consolidated manner. Expose yourself to government debt, and then you have a lean government. And the Fed was really the champion of that. The Fed had always ... I don't know 97 percent of the balance sheet was let's say neutral, so my portfolio, and there were some margin or credit operations with banks to steer liquidity conditions. So that framework, or let's say that balance sheet structure approach has some logic and worked, obviously.

Beckworth: Very interesting question, one we can't resolve here on this show, but one that they keep thinking about. All right, let's take these ideas and the other ideas in your papers, and let's move to the world that we live in today and look at the different types of systems that we have. There's the symmetric corridor system, I think the Bank of Canada for example, they have a very nice asymmetry corridor system, in fact they went from a corridor system to a floor system temporarily during the crisis, back to a corridor system.

Beckworth: The Fed has a floor system. Some countries have a tiered system. You mention New Zealand, also Norway, in fact Norway went from a floor to a tiered and they viewed it as something halfway between a floor and a corridor system. So explain the tiered system to us.

Bindseil: As I understand it, the tiered system is one where you have a certain range of deposits that will get remunerated at the target right off the central bank. So, it's like a voluntary reserve requirements where you can fulfill it or not. So, whether you hold, let's say for a certain bank, 100 million or 300 million, the range in between is remunerated at the target rate of the central bank. If you hold more than this, it gets remunerated at a lower interest rate. And if you hold less than that, then you have to go to a discount window at a higher rate.

Bindseil: And that system I think is very elegant because it provides a daily buffer, because this range can absorb autonomous factor flows. Bank notes are a bit higher but lower everyday than expected. This can be compensated within this tier, so you have a daily buffer without active open market operations and without reserve requirements and averaging. So I think it's an elegant solution to combine lower than daily open market operations with the absence of reserve requirements. So I'm a fan of these solutions.

Beckworth: Oh, good. Let me ask this question. One of the features in this tiered system is that it allows for the reemergence of interbank market activity, which is something also you find in the corridor system, you don't have in the floor system like in the U.S. Tell us why it's so important in your view to have that interbank market active. Why do we want to have an active interbank lending going on?

Bindseil: Maybe it's not so important after all, but it's of course only the other side of the coin. The lengths of the central bank balance sheet, if you have a floor system or let's talk about the floor system-

Beckworth: Sure.

Bindseil: ... you need a longer balance sheet. Because you need to put this excess liquidity into the banking system so that really rates are floored at the rate of remuneration of excess reserves, and therefore you lengthen the central bank balance sheet and you compress interbank markets. In the past, one was convinced that interbank markets are good because they create peer monitoring and they create maybe financial stability in the sense that, these banks are constantly forced to have credit lines to each other, or they are incentivized with credit lines. Then they will monitor each other, they will know each other, they will grant them credit lines and they can compensate for liquidity flows in the interbank market.

Bindseil: While financing in money markets from third parties is less stable maybe, that the bankers know each other, so they have trust, they monitor each other, they would give themselves liquidity even if in the newspaper there's a wrong headline maybe, while the rest of the world is more remote to knowing the bank. I think that was a bit the logic in believing that an interbank market is a good thing for the elasticity of liquidity available to banks, the resilience of banks, et cetera.

Bindseil: Maybe today people believe less into this because they think that, anyway with the regulatory treatment, the incentives for interbank markets are not very strong, so that anyway, let's say the world has to live without active interbank markets playing an important role anyway, and therefore, it doesn't matter if we in addition have a floored system, where all the banks are anyway over-liquid and have no incentives to deal in the interbank market.

Beckworth: Okay. Where do you see the frameworks going? Is there a new consensus emerging? Where do you see central bank say 10 years from now in terms of their operating framework?

Bindseil: It's fascinating to see. The Fed is the most advanced Central Bank now in terms of normalization coming from huge excess liquidity, aiming in principle at a floor system. But maybe without wanting the balance sheet to be excessively long, so then, you have this tradeoff. How much excess liquidity do you need to have your floor, and then you discover the micro properties of specifying a floor system. It's fascinating to watch the landing on a sustainable excess liquidity amount, how this will work. And I think I'm looking forward for that. Therefore it's too early I think to talk about consensus because the irregular ... The Fed, the way it will then specify this floor system in the long term will emerge, and people will look into it and the consensus will emerge afterwards, whether the floor system is superior or not.

Bindseil: I think the main motivation for saying we now may need a floor system, while beforehand we were happy with the corridor system, is the uncertainty on the demand for excess reserves coming from the regulatory side, and that's a relevant argument. So even if you move now back to symmetric corridor system, you have to think through this and also see whether demand for excess reserves makes it more complicated. So, every central bank will face that and we will learn a lot in the coming years on that.

Beckworth: One of the developments since the crisis, has been all these new regulations, which does change the dynamics for excess reserves. Something else that has happened since then is technology making central bank digital cash, a more feasible thing that more likely could happen. Also, there's been discussion of opening Central Bank balance sheets to the public. We've had Morgan Ricks on the show, he's advocated individuals having their own checking accounts at the Fed for example, a Fed account.

Beckworth: I'm curious if you've had any thoughts on those ideas of opening up the Fed's balance sheet to the public, whether through central bank digital cash or through checking accounts. On one hand, the public already does have access to the central bank balance sheet in terms of currency. They don't have access in terms of electronic money and this would be the way to do that. And this would obviously affect the operating framework as well. So any thoughts on this idea?

Bindseil: Yeah, that's a fascinating topic. The question of central bank digital currency opening the accounts of the liability side to the public, not only in the very old form of bank notes but in more modern forms, and intuitively, you could say bank notes, it's paper, it's a bit 18th century technology, you could say or even older. And people, there's a trend to use electronic payments and there are impressive new technologies developing, and being used by people. So central banks ask themselves, “Are we missing a trend here?”

Bindseil: And then there were official papers, BIS papers looking into central bank digital currencies. And there was a lot of worries also raised by central bankers at offering electronic deposits to the public would destabilize the banking system, because both in a structured manner and even more in a crisis, people will bring their money to central bank accounts because that's secure. Let's say central bankers have I think seen predominantly dangers here in something that does not yet exist.

Bindseil: And one again taking a very practical perspective, I think you can control the liability side. That's what we do, we have already now... Taking the ECB example, or the Eurosystem example, we have non-bank accounts and those are accounts granted to official sector institutions, both Euro area governments but also foreign central banks who want to hold Euro deposits also with the Central Bank. I think something that we're doing is tiering again in a somewhat different sense, that you allow them to deposit at a relatively attractive rate up to a certain ceiling.

Bindseil: And beyond that ceiling, you still allow them to deposit, but at a less favorable rate. And this less favorable rate, you can put it at the level where you make sure that it will not balloon in an uncontrolled manner. So in my view, one can control this problem. I think central bankers, some were a bit too worried I think from this perspective on central bank digital currency.

Beckworth: Okay. Our time is almost near an end. And I have one last question I want to ask you, and this moves from the operating framework to the overall framework for monetary policy, and here in the U.S. we're having a discussion about monetary policy frameworks. Should the Fed stick with two percent inflation target? Should it go to average inflation targeting, a price level target, a normal GDP level target? Is there any conversation at the European Central Bank on that same issue? Is there any interest politically from all the constituent countries for thinking about a different framework for the European Central Bank?

Bindseil: There's nothing there. The Fed was very open and has launched a public process in looking at all those questions. So there's nothing comparable here yet, I don't know if that will ever come. Of course every central banker is well aware that we're somewhat living in a different world today than the world of Volcker in the early '80s, where the lowest is zero lower bound has become an important issue. Let's say the concerns on inflation were clearly asymmetric in 1980 towards inflation side.

Bindseil: Now they're almost asymmetric into the other side. So, I fully understand the logic under which the Fed has opened this debate. Why it has been opened is, I think it makes sense. ECB has not done it yet. But I guess every central banker in the world is aware that we live in different contexts than we lived maybe 40 or even 20 years ago, and that you can revisit your strategy from time to time.

Beckworth: Yes. The lower natural interest rate, or lower “r-star” as they say here, has been a big part of that motivation for the Fed. And if it persists, if we continue to live in a world of low interest rates, I imagine at some point the ECB will also get interested in having this discussion. And it'd be interesting to see if there's public support for something like that in Europe. It seems to me it'd be a lot more complicated over there, because you have all these different countries that have to sign off on it.

Bindseil: Well, I wouldn't say so. I think on the operational framework side, there's more complication from having 19 countries than on the macro strategy side. You mentioned those possible … or the changes considered in the U.S. in averaging a nominal GDP. Those things, I think changing them is a bit independent of fragmentation issues that you may have in the monetary area. Fragmentation is always a problem, but I don't think it makes it more complicated to change the definition of price stability in some way.

Beckworth: Now that's just great. Okay. Our time is up, our guest today has been Ulrich Bindseil. Ulrich thank you so much for coming on the show.

Bindseil: David, thank you for your great questions. Thanks.

Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. If you haven't already, please subscribe via iTunes or your favorite podcast app. And while you're there, please consider rating us and leaving a review. This helps other thoughtful people like you find the podcast. Thanks for listening.

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