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David Beckworth: Mark, welcome to the show.
Mark Carney: David, thanks very much for having me.
Beckworth: It's a real honor for me to have you on the show. I've been following you for many years. I followed you all the way back at the Bank of Canada, the Bank of England. And as listeners of the show know, I'm a big fan of nominal GDP targeting. So at some point in this conversation, I want to talk about that. But before we do that and you get into your book and some of your experience in central banking, tell us, how did you get into this career path? What put you on this storied career path that you've had?
Carney: Well of course the reality with almost all our careers is a heavy element of luck, and I do remind myself of that. I did when I became governor of the Bank of England, that it was a series of fortunate events or unfortunate events, depending on your perspective. But I started studying economics, I was attracted to economics because of the mixture, of course, the discipline of the market and the rigor of the discipline, I like mathematics. But I like the blend of history of human psychology, of the political economy and those aspects. And what's interesting is that as I went through my studies, like many of those who are listening to this, it gets distilled over time, more and more. Certainly at the time when I was taking economics, undergrad and certainly graduate economics, it was the high time of game theory, rational models, tractable models, and certain approaches to the world that fit together in a beautiful mathematical hole, but arguably didn't really represent how things work. So I had to unlearn some of that over the course of my career.
Beckworth: Now you joined the Bank of Canada in 2008, is that correct?
Carney: Yes. I became governor in February of 2008. So February 1st, 2008.
Beckworth: Yeah. You were there before, to be clear, you were there before. But you jumped in right in the middle of the Great Recession. So they threw you into the deep end of the pool, sink or swim. So that must've been quite an experience to have to become a central bank governor right in the middle of the Great Recession.
Bank of Canada: Review Process & Response to the Great Recession
Carney: Yes, it was an interesting experience, to say the least. More interesting in hindsight. It was slightly terrifying at the time. But we had one advantage in Canada, which is that in the summer of 2007, and I talk a bit about it in the book, the asset-backed commercial paper market in Canada froze up. It's a sleepy corner of the global money markets, global capital markets. But it froze up because it was the canary in the coal mine for a super structure known as SIBs, which includes SIBs monoline insurance, CDO-squares. And we realized very quickly that this sleepy little corner in Canada of about $20 billion Canadian of commercial paper was supporting credit risks and a credit architecture of well over 200 billion in London, particularly. And our sense was, well, if this is going on here, just imagine the scale of the leverage in the major financial centers, which unfortunately turned out to be true. So I would say that while I didn't have perfect foresight of what exactly was going to happen when, we did have a pretty good idea that this was not going to end well.
Beckworth: One of the innovations you undertook at the Bank of Canada during this time, as you went from your symmetric corridor system to temporarily to a floor system, as the balance sheet expanded. And then, I believe 2010 or so, you went back to a corridor system and the Bank of Canada was one of the few central banks to do this. They expanded their balance sheet when you hit the lower bound, which made sense. And it's almost like textbook perfect. How is it that the Bank of Canada was the only central bank to expand its balance sheet and then shrink it again and go back to a corridor system after the crisis?
Carney: Well, it's a combination of economics and institutional structure. So the underlying economics meant that we needed to get to the zero lower bound, we needed to provide liquidity to the financial system, even in Canada because of the global tensions. But we also felt that we could substitute duration for quantity by which we translate that into that's where forward guidance came in. So providing time-contingent forward guidance. It sounds very archaic when I say it now, but that's what it was at the time. It was innovative back in 2008. Time-contingent forward guidance provided that extra stimulus.
Carney: And the reason why I alert to the underlying economics is of course, what happened as we went from late 2008 into 2009, is there was a global commodities boom. In part, because of the big Chinese expansion and Canada got some of the real and nominal, very importantly, nominal benefit of that, which flowed through to the economy. So we didn't have to engage in large scale, quantitative easing. We didn't have to take the shadow rate deeply negative. And we were fortunate in that respect, but we use the tools that we had in the way you described.
Beckworth: Well, that's interesting. It reminds me of Australia as well. They also benefited from that boom. So both of those countries did relatively well compared to the US and Europe during this period. Now something else that I find fascinating about the Bank of Canada is the review process there. And my understanding is it's been going on for a long, long time. Is that correct?
Carney: That's correct. The bank adopted inflation targeting in the early 1990s. And as part of that, there was a five-year review instituted. So between the bank and the Department of Finance, what the treasury is called in Canada, go through a review process. Ultimately, it's the minister's decision in terms of what the specific inflation target is or the inflation framework is. That's how it's grounded within the Bank of Canada Act. David, I'll say when it was first put in place, Governor John Crow was the governor at the time. We started with a 2% inflation target. The expectation was that these reviews would lead to a 1% and maybe a 0% actual price stability. That never came to pass. The learning was the advantages of the 2% target. Tremendous amount of analysis and review of different options, some tweaks here or there, but the system hasn't changed that much, even though there have been a large number of these reviews over time.
Beckworth: So when you do the reviews of the Bank of Canada, is everything on the table, the target, the tools, as well as the operating system?
Carney: Target, tools, operating system, yes. Although, operating system really left with the central bank, the plumbing left with us. Certainly the target. And over the years, we've looked at things including nominal GDP targeting, get you excited there.
Carney: Nominal inflation targeting, average inflation targeting as examples. After I left, when I was at the Bank of England, the Bank of Canada looked at raising the inflation target to try to get additional stimulus there. The one thing that's not on the table is the interaction between monetary policy, supervisory policy and macroprudential policy, because the Bank of Canada is largely a monetary institute, to use the English phrase. It does have a financial stability analytic responsibility, and it oversees the payment system. But it doesn't supervise banks, unlike the Federal Reserve System or the Bank of England. And it doesn't have any explicit macroprudential responsibility. So what's missing from the Canadian system, in my judgment, are those interactions between monetary policy and the financial system, or at least the explicit aspects of that.
Beckworth: Would that be a decision for Parliament or the finance ministry to make?
Carney: Yeah, it would be a parliamentary decision.
Carney: I'm making an observation as opposed to a criticism. As you well know, there's path dependence in these arrangements. It has worked well to have a separate bank supervisor, it's called OSFI in Canada. And actually the thing that concerns me, I'm happy to say this, is that the macroprudential responsibility is less clearly specified in Canada. So for example, you're well familiar, you have the FSOC in the US chaired by secretary of the treasury, which is a way of, I don't think they use the term macroprudential as formally, but it is a way to look at those issues. In the UK, that macroprudential responsibility is housed in the Bank of England. Explicitly in Canada, it's ultimately the minister's responsibility, minister of finance, it's his responsibility, but there's not a formal committee, there's not a formal structure, there's not formal parliamentary remnants that are applied. And to my way of thinking, that's an element of the system that could be improved.
Beckworth: Two more observations about Canada and we'll move on to the Bank of England. But something that I learned over the past few years when the Fed was having problems with its plumbing, so the repo crisis in late 2019, September, 2019, and then of course, March last year, is that the Bank of Canada automatically buys a certain small percent of the public debt that's issued in a given period. Is that right?
Carney: That's correct. Yes.
Beckworth: So that facilitates smooth functioning of debt markets and such. And it's something that the Fed used to be able to do in a small amount, but can't anymore. And some have suggested that would have made some of these hiccups easier to handle.
Carney: Yeah. Possibly. Although, my only counter to that is if you're buying a small amount anyways, it just means the issue size is slightly smaller. And so the challenge-
Carney: Yeah, the question is, I'm sure in fact you've gone through some of the plumbing aspects of the so-called dash for cash, which is a very polite way of describing what happened last Spring.
Beckworth: It's fascinating. It's fascinating, yeah.
Carney: And so I don't think that just being a bid, a small bid in the market, would have made a difference there. And of course, the Fed had to take quite extraordinary steps in order to stabilize it.
Beckworth: You say the dash for cash. It really was a dash for cash, which is something that as an academic, you tend to forget. You think of the fiscal theory, the price level, where you say, look, short-term T-bills and reserves, they're perfect substitutes. But in March, they weren't. People were literally dashing for reserves, for cash. And it was a striking moment. People wanted the unit of account, the final settlement balance. One last observation about Canada before I move on is the incredible stability of the banking system there. You guys have had a history, going back a long time, and I know part of it is an oligopolistic banking system, it's more concentrated, but you got branch banking. And my understanding is you didn't have one bank shut down during the great depression, where in the US, we had like 9,000, and it's been a periodic problem in the US. So we don't have time to get into it today, but I just look up at Canada and I see this amazing system and wonder, "What could we learn from that here in the US?"
Carney: I'd say very quickly, two things that stuck out in the crisis. One was, and I mentioned it in the book, not about the banking system per se, but just in general, in finance, if something doesn't make sense, it doesn't make sense. Make sure you understand it, it can be explained to you. And if I'm explaining something to you, come back to me if it doesn't make sense. If I can explain it the second time around, I probably don't know what I'm talking about or the product or the trend or whatever, doesn't hold together. Second thing, it's been observed many times, the leverage ratio. That protects you against risks you think are low but in fact, aren't. We had a quite well specified leverage ratio going into the crisis. And that saved the banks from subprime, full stop.
Nominal GDP Targeting at the Bank of England
Beckworth: All right, well, let's move to the Bank of England and you begin your journey there in 2013. And during this transition period, I believe you gave a hearing, or you gave testimony to finance ministers, to Parliament, I forget exactly who. But in that hearing, you talked about nominal GDP targeting. So I want to drill down on this. What do you find appealing? Because my understanding was you actually were supportive of that idea. What do you find that you like about nominal GDP targeting?
Carney: The first thing is, is a bit of context, which is that the UK had had a very difficult post-crisis period, was well below post-crisis levels of output, nominal output, at that time, so five years after the crisis. And had been quantitative easing was, what then was thought as the effective lower bound. So the question was, "How could we provide additional stimulus to the economy?" So that's in part of the context.
Carney: Second piece of context, you touched on it earlier, David, we had looked at nominal GDP targeting or variants of nominal GDP targeting when I was at the Bank of Canada, and could see in theory, very important point, in theory, the power of nominal GDP targeting, the effect on agents, the way you can provide additional stimulus and provide that anchoring of expectations that can become self-fulfilling. So there were obvious attractions there. Third point of context is that the inflation target had become more narrowly specified in practice so that the sweet spot of monetary policy returned inflation to target in 18 or 24 months. And you can certainly envision circumstances, both those from below and from above, where you would want to take longer in order to bring inflation back to target. So when I was arriving there inflation was above target, in part because of exchange rate weakness, it was very high pass through there. And the issue was, would you really tighten interest rates for those purposes as opposed to support the growth of the economy? And so there are a variety of reasons why nominal GDP targeting had attractions. Now the challenge in the UK, one very basic challenge, you would have heard this in your discussions previously. But in the UK is the statistics are, I don't want to say they're unreliable, but they're variable. And they get substantially, substantially revised, including on a nominal basis.
We had looked at nominal GDP targeting or variants of nominal GDP targeting when I was at the Bank of Canada, and could see in theory, very important point, in theory, the power of nominal GDP targeting, the effect on agents, the way you can provide additional stimulus and provide that anchoring of expectations that can become self-fulfilling. So there were obvious attractions there.
Carney: So there's not a canceling out of the real versus nominal, not a reapportioning. And so you could be targeting something that changes dramatically. And in fact just before I arrived, the UK was on the cusp. They narrowly missed it on the measure of numbers of a triple dip recession. So three recessions in near succession. As it turns out with subsequent revisions two of those dips never happened. And the nominal path, it was big enough to make a material difference to the stance of monetary policy.
Carney: Last point if I may, what we did in lieu of moving to nominal GDP targeting, it was a reasonably healthy debate about it, which is what we wanted, was the remit is the way the UK talks about the mandate, the equivalent of that five-year in Canada. The chancellor sends a letter to the Bank of England Governor, the committee and says, this is how we interpret that inflation target or the inflation targeting framework. And what George Osborne, who was Chancellor then did his letter said, don't forget about the flexibility and flexible inflation targeting. Don't forget that you can stretch out the time over which you return to target from above or below.
Carney: And that turned out to be, it's not nominal GDP targeting, but it moves you along the continuum towards that. And it's also last point, is incredibly important because one thing that is a bit missed is that throughout the post-great recession or post-financial crisis period, the Fed and the ECB, they're all in divine coincidence territory. So in other words, inflation is below target and there's an output gap. And so both of those aspects pushed in the same direction for looser policy. Whereas the Bank of England quite frequently had inflation above target because of exchange rate pass through, and a big output gap. And so we needed to have a trade off. And when you get into trade off territory that's where you need that flexibility. And that challenge is going to sound pretty familiar to people around the world.
Beckworth: Right. Well I think it's interesting when you look at the UK's nominal GDP. So outside of the great recession and then the pandemic, it was a relatively stable growth path. I mean effectively what you saw was an outcome like nominal GDP targeting. So I know last year there was some discussion about it in the finance ministry again. And as I was looking at that time, and it struck me it wouldn't be that hard of a transition. I mean there's these practical issues you raised, data revisions and other things, but effectively it looked like the UK was doing something like, the outcome at least was like nominal GDP targeting already.
Carney: I think that's right. But when you get towards the effective lower bound, of course it gives you additional stimulus. And as you well know, David, that's part of the logic with the average inflation targeting. It's not nominal GDP, but it's part of the logic. Average GDP target again, hearken back to my Bank of Canada days, if I compare price level targeting, so not normal GDP but price level targeting, average inflation targeting will get me about 80% of what a price level target would do. And particularly in a way that perhaps is more understandable, although people can debate that, then talking about inflation with adrift. As opposed to anchoring a target and doing some element of makeup, which of course is what the Fed is attempting.
Beckworth: Well I think nominal GDP targeting is a mouth full, not the best marketing phrase, but I do think that the other way of framing it as a nominal income target, like it used to be called back in the '80s when McCollum and those people were discussing it. And I think, I support and I'm excited to see the Fed's average inflation target because it does have elements of makeup in it, but I also realize it's a hard sell. You've got to tell the public, we want to have higher inflation, and it's temporary. Whereas if you had a nominal income target you could say, hey, we want to get your incomes back to where they were pre-crisis. We want to get yourselves back to where they were pre-crisis. And for me that seems like an easier sell than saying, hey, we want to get inflation up, which is a symptom of getting income and sales back to their pre-crisis trends.
Carney: Can I make one other point? Because I know this is an area of enthusiasm for you. So one of the things with price level targeting, just make quick point on that, which is that if you had price level targeting with no drift, so you targeted a flat price level. So very easy to communicate: ‘our prices on average are not going to increase.’ Of course there's issues with lower bound, et cetera. But what that would tell people was that anytime you saw inflation in a price, that you would judge that price against a change in quality. Is the product really worth something more if it's price has gone up? That's the first point. Second point, the analog in nominal GDP targeting, or as you reframe it rightly, nominal income targeting, is then I looking at my wage and my income, and I make a judgment. Am I getting ahead or not in relative terms? Where do I show relative to nominal drift? And we're not in a world of wage price spirals and there's information. And from a labor market functioning there are some attractions there. So we'll see, we'll see how average inflation targeting does.
If you had price level targeting with no drift, so you targeted a flat price level. So very easy to communicate: ‘our prices on average are not going to increase.’ Of course there's issues with lower bound, et cetera. But what that would tell people was that anytime you saw inflation in a price, that you would judge that price against a change in quality.
Beckworth: Okay. Yeah, I don't want to eat up all our time, I want to get into your book. But just one more question since you are a prominent former central banker. You mentioned the data problem, there's data revisions. And I have my own ideas how to get around it, but one comment that's been raised about that issue is if a central bank were to adopt a nominal GDP target, and hopefully it would be a level target, then the data would become endogenous to that target. In other words, if the Fed were to adopt such a target it would put researchers to work to get real spending transactions from online or some other way. If you build it they will come kind of idea. Do you think that's fair or am I being overly optimistic?
Carney: I think the distinction of course is, I mean the Fed is not responsible for the national accounts. So yeah, will it incentivize those who compile them to do even better? Always be nice to statisticians to do even better, but it's tough work. The challenges and stuff work and revisions, sometimes you need all the information in order-
Beckworth: Absolutely. But I know you've had people at the Bank of England working on this, I know at the Fed people who were doing real time data collection, which I know there's all kinds of problems with that, but you could really put that to use. But let's move on because I do want to get to your book. I do want to ask about your view of the future of central banking. So we mentioned the Fed's average inflation target, and for me I view this as an historic moment. This is the first time a modern central bank has adopted a version of price level targeting, a watered-down version, but it's never been done before.
Beckworth: I mean the only other central bank I know is the Riksbank back in the 1930s did a price level target explicitly. And it's new, right? It's something that hasn't been seen before, so I think some of the consternation we're seeing in the US about this is it's new, people have a hard time handling inflation running a little bit hotter than the normal. So I think we're going through the growing pains, we're all kind of groping in the dark trying to figure this out. But my question to you is this, let's say the Fed is successful, it builds up credibility, and it does effectively have a form of price level targeting against watered down. Do you think this could be the beginning of a sea change where all modern central banks, or advanced economy central banks do this? In other words, could the 2020s be what the 1990s were for just regular inflation targeting, but now for price level targeting?
The Fed’s Average Inflation Target
Carney: Possibly. As you know, it's fairly restricted at least at this stage, in that it is, I'll call it Bernanke style average inflation targeting. In other words, it's a tool when you're at the effective lower bound. Rather than quadrupling quantitative easing you flip to average inflation targeting, you get the benefit of the expectations that build up there that helps with the stimulus. But it's not a tool for when rates are above the effective lower bound and the economy's moving forward. So it there's a long distance of travel between something that's a part of the, I don't want to call it an emergency toolbox, but the distressed toolbox that we're operating in for it to be the core framework.
[The Fed's average inflation targeting is] a tool when you're at the effective lower bound. Rather than quadrupling quantitative easing you flip to average inflation targeting, you get the benefit of the expectations that build up there that helps with the stimulus. But it's not a tool for when rates are above the effective lower bound and the economy's moving forward.
Carney: But the last point, I do think that we're having a period of introspection about monetary policy frameworks and the objectives. And you saw Olli Rehn's comments the other day at the ECB, and you have these reviews in Canada that happened naturally, in fact it's due later this year the Canadian one. The Bank of England's looked, others will be looking. And that's healthy, it is healthy to look at these frameworks. Even if it ends up back in the same place, properly having debated is absolutely essential I would say.
Beckworth: All right. So in your book, again the title of it is Value(s): Building A Better World For All. And we'll come back to your executive summary, your tie in, but I want to tie in one chapter in there, chapter six talks about money. And you bring up central bank digital currency and cryptocurrencies. And I'm just wondering, do you see this being a future for central banking? Are we headed to a path where most advanced economies, central banks have central bank digital currency?
The Future of Central Bank Digital Currency
Carney: In a word, yes. For several reasons. One, I think that periodically, not that often, but periodically there's innovation in money. And you think of bank notes in the seventh century, and the gradually developing account-based money, the bank of Amsterdam and the Dutch financial reforms, and the revolution in the 1600s, fractional reserve banking in the 19th century with endogenous money creation in banks, et cetera. You get these. And I think we're at another period of time where the nature of the economy and the opportunities that are afforded by developments in cryptography, and I'll just use the shorthand of broader FinTech, create these opportunities.
I think that periodically...there's innovation in money. And you think of bank notes in the seventh century, and the gradually developing account-based money, the bank of Amsterdam and the Dutch financial reforms, and the revolution in the 1600s, fractional reserve banking in the 19th century with endogenous money creation in banks, et cetera. You get these. And I think we're at another period of time where the nature of the economy and the opportunities that are afforded by developments in cryptography...FinTech create these opportunities.
Carney: But in all of those other examples, ultimately what happens is the core of the system reasserts itself. And there is the state, or the central bank on behalf of the state, at the center of the system. Whether it's the note issuer or the lender of last resort for fractional reserve banks as that role develops. And I think in this case with the core money, which would be a central bank digital currency, which provides at least the top tier of the new system. And it's a tremendously interesting timing, but I do think that's where it's headed. There is a huge series of questions that have to be answered in order to go from that statement to actual implementation. But I would suggest that it's occupying a considerable amount of time within those institutions at present.
Beckworth: Yeah. I like what Fed Chair Powell says, we don't need to be the first one out the gate, just make sure we do it right when we do bring it on board. You are well-known for your 2019 Jackson Hole speech you gave. In fact, I was there, I was in that little room when you talked about this synthetic hegemonic currency. And I was like, wow, that's a pretty bold call there. And maybe you can summarize your SHC, it's like synthetic upon synthetic central bank digital currency, but maybe you could explain it to our listeners and just tell us what's been the reception to the idea.
Carney: Well I was making a couple of points. One, as I said, I was painted for it from Ben Bernanke, because Ben Bernanke's last speech to central bankers when he was chair of the Fed said, "I've dealt with a lot of things." Which was true, but he was very modest about his accomplishments, but he said, "The one thing I can't figure out is what to do about the international monetary system, because it's got this fundamental problem at heart." And a spade, a spade, there is a huge asymmetry at the heart of the international monetary system with dollar dominance and the multipolar economy, lots of issues around that. And I'm not saying it's about to change overnight, but that's one fact.
Carney: The second fact, and by the way that breeds instability in emerging economies that makes the global economy more challenged. The second fact was at the time there was a hegemonic currency being proposed by Stealth, which was Libra, which was a stable coin, which is a form for those who don't follow closely cryptocurrency, but was going to be based on a basket of the major currencies. And so the point I was making was now when you have conditions eventually for a shift in reserve currency, because we have this dysfunctional structure that's only growing at the heart of the monetary system. Second point, when there's a change in reserve currency, it's driven by means of payment. So what happened when we went from pound sterling to dollar is more and more people in the late 19th century, early 20th century paid for commodities and goods in dollars instead of sterling. And it's that pricing in dollars that means of payment and use of dollars, that drives the financial architecture that builds off it.
Carney: Now, my point was that, okay, we have this huge growth in digital which has only accelerated since that [Jackson Hole] speech, and if the unit of account and means of payment is Libra, which is a basket of currencies, that has some potential to start to displace and start this restructuring. And the point, which was just to finish the logic, and if people are still with me and I congratulate them…
Beckworth: No, this is good stuff.
Carney: Which is to say, we want to move towards more of a multipolar system, because it'll be better for the global economy. And so, we should own the currencies, we, the central bank, should own the currencies that are the heart of digital payments. In other words, we should have central bank digital currencies. That was the heart of what I was saying. And if we did that, there are ways to knit them together in this synthetic way that would help, we could kill two birds with one stone. It was a very ambitious speech I would say, David, for a lunchtime audience at Jackson Hole, when all everyone really wanted to do was to go hiking.
We have this huge growth in digital which has only accelerated since that [Jackson Hole] speech, and if the unit of account and means of payment is Libra, which is a basket of currencies, that has some potential to start to displace and start this restructuring...towards more of a multipolar system, because it'll be better for the global economy. And so, we should own the currencies, we, the central bank, should own the currencies that are the heart of digital payments...And if we did that, there are ways to knit them together in this synthetic way that would help, we could kill two birds with one stone.
Beckworth: Well, actually I had a conversation with some people about that speech during the hike. So it definitely got us thinking. But what has been the reception? Let me present the biggest barrier I see to that being implemented, and that is just, as you said, dollar dominance, the scale of the dollar assets out there.
Beckworth: So I've had some previous guests on the show and we've talked about magnitudes. If you look at all the dollar assets, we've exported from the U.S. to the world, if you look at all the BIS, they collect data on dollar liabilities being created outside the U.S., you're getting 30 trillion, depending on what you want to measure, you can get 30 trillion plus in dollar-denominated assets, and you'd have to compete against something that big. And so it'd be a big scale. Would it not require the SHC to scale up to something that size, or at least a meaningful portion of that to make it competitive?
Carney: To be absolutely clear what the core of what I was drawing attention to was we have a big problem in the system, and we still do, same point. Secondly, don't let Libra become the core of the system, we should own the core of the system, we should have central bank digital currencies. And in that regard was part of a broader campaign to launch central banks to work on central bank digital currencies. Within a few months, Christine Lagarde and I formed a group, a core group of central banks. The Fed subsequently joined that group, so that's why there is a big group, or that's one of the contributing factors to that.
Carney: In terms of regime switching in reserve currencies, it happens very rarely, but it does happen. And it ultimately is driven by the underlying economics. And I’m not clear when it will. I do think though, the last point, which is that, and this goes back to whether you have a central bank digital currency, if you're the Bank of England, Bank of Canada, some other currency, what you don't want is that the only digital means of payment for a smart contract for a digital online is dollar-based, because all that's going to do is reinforce dollar dominance.
Beckworth: Yeah. So your point is, if I can summarize, is the SHC is kind of like the tail end of a broader argument, broader point.
Carney: It was the logical conclusion of a broader argument. But David, I was perfectly happy to accept that central banks would have central bank digital currencies and displace Libras/DM, sorry, those advocates of that. And it seems we're at least headed in that direction.
Beckworth: Absolutely, absolutely. Okay, let's move to your book. We've been touching on areas in your book as you've mentioned, but let's talk about your book again, the name is Value(s): Building a Better World For All. Why don't you give us kind of the executive summary of it and we'll delve into some of the topics you cover?
*Value(s): Building a Better World For All*
Carney: So part of it, and we touched on a bit of it when you asked me about my career in economics, which is this sort of drift in terms... The book looks back at the history of how value is seen, and the rise of what's called the subjective revolution, where you combine that with marginalism so that the price becomes value, value is in the eye of the beholder. And taken to an extreme, if something doesn't have a price, it doesn't have value.
Carney: And it goes through the experience of that, and then brings that towards how markets function, and then how we can use certain markets to achieve societal values. In essence, what it's doing is reuniting the two halves of Adam Smith, invisible hand of Wealth of Nations, and the social construct of the market in Moral Sentiments.
Carney: And we talked about, I'll give you two extremes of it, we talked about the example of what happened with the financial crisis and the buildup to the financial crisis. And in the run-up to the financial crisis, and I was part of this very strong belief in markets and the solution, if there was market failure was often to build new markets. It was this sort of Arrow-Debreu type approach, that this is just an absence of completion of markets. So if we complete markets, we'll be okay.
Carney: And that's part of the way you end up with CDO squares, by the way, markets on markets on markets. Well that doesn't fully work as we saw, that's one extreme. And also in that process some of the underlying values, the moral sentiments, to use Adam Smith's terminology, that underpin markets, certain values that underpin effective markets functioning were undercut through behavior and other aspects. So that's where value undercuts values.
Carney: The other end of the extreme is what I'm arguing is beginning to happen with climate and sustainability, where more and more weight is being put on, "Okay, let's deal with climate change, let's move towards a net zero economy over time." And that is the objective; that's the societal objective: let's have sustainability. Well in that world, once it becomes obvious that that is a hierarchical value, then markets organize themselves to deliver that, to deliver that solution; and tremendous value, financial value, commercial value, is created in the process.
Where more and more weight is being put on, "Okay, let's deal with climate change, let's move towards a net zero economy over time."...that's the societal objective: let's have sustainability. Well in that world, once it becomes obvious that that is a hierarchical value, then markets organize themselves to deliver that...and tremendous value, financial value, commercial value, is created in the process.
Carney: And I'd argue, I'm feeling reasonably confident about this just having been part of an effort that signed up $70 trillion of financial institutions for net zero by 2050s, which was announced with the Biden Summit, that the core of the financial system is moving in that direction. So that relationship, and I'll finish on this, between value and values can go both ways. Value markets in service of societal values, that's the best of all worlds, or if we get the values component of it wrong, if we take it for granted, it can actually undercut the functioning of the market as we saw in the financial crisis.
Beckworth: That's very interesting. I was thinking about this as I read your book, and I've heard several other discussions by free market people like myself who love capitalism and all the good that it's done, but does capitalism by itself begin to erode values? Like you said, The Theory of Moral Sentiments compliments The Wealth of Nations, is there a tendency do you think for capitalism to lead to some kind of amoral direction or push? Or is it just the underlying culture, or anything else?
Does Capitalism Corrupt Our Morals?
Carney: I think it's, the answer, it doesn't necessarily have to. I'm a huge fan of markets, I've been in and around all sides of markets, really my entire career. And it's the most powerful instrument we've ever invented, but it does require some regulations, some market infrastructure, and certain values that are consistent with markets fulfilling their role over time.
Carney: And we all know, and certainly those of us who are involved in financial markets, that they are prone to excesses of exuberance and despair. It's not the rational expectation, everyone's not rational. There are human frailties, there are market shortcomings. They interact in a way that can undercut the effectiveness of markets.
Carney: And the question is, what do you do about it? How much of that is through regulation and how much of that is through reinforcing the right values around markets? And the book goes through a number of examples where that's the case.
Beckworth: You just mentioned financial markets and the excesses that can emerge there from time to time. And you mentioned the financial crisis, or the great recession 2007, 2009. And you also have the perspective of being at two central banks, and the chairman of the Financial Stability Board. So when you look back at the crisis in that period, the Eurozone crisis, what we're going through, what do you see as the key issues in our financial system?
Key Issues in the Financial System
Carney: Well, I think the first is, and this is a born directly from Hyman Minsky and Rogoff and Reinhart of, I talk about in the book, the three lies of finance, and the first is, "This time it's different." Something fundamentally positive happens, it leads to new paradigm thinking, there's lots of good that comes from that, but it can be taken to extremes. And then leverage is built upon that in the Minsky moment that comes from that. And we've seen that time and time again.
Carney: I think the second thing, and related to this, and this is probably the toughest challenge for the policymaker and certainly a policymaker who believes in markets is one's tendency either to think markets are always right, or to think that markets will always clear. You get sucked into liquidity illusion in markets, and so the expectation is they will find their price and sustain their price. Well, there are a number of examples where that doesn't happen.
Probably the toughest challenge for the policymaker and certainly a policymaker who believes in markets is one's tendency either to think markets are always right, or to think that markets will always clear. You get sucked into liquidity illusion in markets, and so the expectation is they will find their price and sustain their price. Well, there are a number of examples where that doesn't happen.
Carney: We talked about one a few minutes ago with the most liquid market in the world, the U.S. Treasury market, because of market structure, a combination of that and panic, which sets in when assumptions are disabused. And then the last aspect is around the morality of markets. And to be clear, as I say, a big believer in markets, but this presumption of the values that underpin it. So are people acting responsibly, fairness, do institutions have some sense of the system and their end clients? And how do you reinforce that?
Carney: When we looked at the financial reforms, we had very specific things to do, fix problems in the shadow banking sector, one aspect. Banks didn't have enough capital, second aspect. Change the structure of derivative markets, third aspect. But we recognized that we needed to instill a degree of responsibility in senior managers for their institution and for the system as well.
Carney: And different jurisdictions did that to varying degrees. The UK, it's very strongly in place in terms of both the compensation structure and the expectations as a supervisor of those senior managers. So in the end, the last thing I'll say is the challenge is that the half-life of memory in financial markets is very short, and people forget, people turn over and forget. And so, as a policymaker for the central bankers listening, one of our jobs is to plan for failure. Don't think about why the bad thing isn't going to happen. Think about what you wish you would have done once it happens, and do it today. And so put those buffers in, build that diversity, make sure you have the emergency tools, do that planning today so when the bad thing happens, or something similar to it that you don't expect, you're ready.
The challenge is that the half-life of memory in financial markets is very short, and people forget...And so, as a policymaker for the central bankers listening, one of our jobs is to plan for failure. Don't think about why the bad thing isn't going to happen. Think about what you wish you would have done once it happens, and do it today...put those buffers in, build that diversity, make sure you have the emergency tools, do that planning today.
Beckworth: One more question about financial regulation and we'll move on, I like having you here to draw upon your experience, one of the concerns that many of my guests have expressed before, and many have written about this is this dollar-dominance, the global shadow banking system. So even if we tighten say regulation in the U.S. so that we can minimize runs on dollar liabilities or money-like liabilities, there's all these other firms overseas doing the same thing. And it's kind of a whack-a-mole game. You're trying to get one firm, and then they go somewhere else and do it.
Beckworth: And as a response, the Fed had to step in last year with its swap lines, all of its facilities to keep the dollar funding markets running. And what do we do about that? Or maybe we do nothing at all, I don't know. What are your thoughts about the growing dominance and reach of the global shadow banking system?
Dollar Dominance and Shadow Banking System
Carney: And this is one of the elements of your favorite speech at the Jackson Hole. So I can go back and look. Because one of the points that I made in that speech, just to reinforce your premise of the question, is that there have been a number of institutional improvements, I'm saying broadly speaking in major emerging economies; more inflation targeting central banks, and by and large, more capital in the banking system, better fiscal policy, there are exceptions, but by and large it has been the case.
Carney: And there are some analysis of that in terms of GDP at risk, that that type of approach. And I think you had somebody on recently who was talking about this, and there's been some analysis of that, which shows that actually it's reduced the tail, the left tail, quite substantially. But what's happened at the same time is greater dollar dominance, and relative to the size of the U.S., which means that you can have monetary policy in the U.S. not in sync with the requirements of the emerging economy, you understand the tension, and the growth of market-based finance or shadow banking, including funds that aren't necessarily based in those emerging economies, they're based in the U.S., and the UK, and Europe, but they're offering daily liquidity and investing in emerging market debt, which of course under stress is a very unstable dynamic.
Carney: And actually that has largely canceled out the institutional improvements in terms of the net riskiness. So it's a real issue. Now, what do you do? Which is to the core of your question. And this is true for shadow banking, it's true for banking, cross-border banking, derivative markets, other things, is you try to come up with agreements at the FSB of minimum standards in those areas and then you can't. It's not a treaty based organization. When people go home they don't have to implement those agreements, but you monitor that and you watch and you're building again, this common understanding of the system, the risks that are being derived, you have a sense of ownership because countries have been part of the development of those agreements and then they've been implemented. I will say David, that from my time at the FSB and just up until when I left as a governor of the Bank of England, the toughest area to get those agreements on was in exactly the area you're talking about. I wouldn't say shadow banking as a whole, but on asset management, daily liquidity funds, investing and increasingly liquid.
From my time at the FSB and just up until when I left as a governor of the Bank of England, the toughest area to get those agreements on was in...asset management, daily liquidity funds, investing and increasingly liquid.
Carney: That's an example of an area where you hadn't had and we didn't have until the spring of last year, in the US first, that panic on a scale where you had to have large scale central bank intervention because remember what happened in the spring first or not first, but in parallel to those international swap lines, was the FED putting in place, very large facilities to buy, not provide liquidity against, to buy corporate debt in the core US market. That tells you something about the market structure.
Carney: Last point is that what we're seeing is of course the FSB is taking a look at this in a so-called holistic manner as the Fed and the SEC in the US.
Beckworth: Let's move to the climate change issue and you covered it fairly extensively in your book. What role do central banks have to play in that?
Combatting Climate Change
Carney: It depends on the central bank. If you're the Bank of England and you don't just do monetary policy, but you oversee the insurance market, including Lloyd's of London, which is one of the biggest catastrophe risk insurers. It's pretty straightforward. You instantly have a supervisory responsibility, make sure they have enough capital against extreme weather events and how those change. If you have macro prudential responsibility, in other words, making sure the system can withstand a systemic risk. With climate, one of the biggest systemic risks is actually the transition towards a more sustainable economy. It sounds a bit like a paradox, but the fact is that if that transition is smooth and predictable, then market functions well, certain assets are gradually retired, lower carbon assets come into play and the banks and other financial institutions adjust. If it's a delayed in quite abrupt transition, then you will end up with stranded assets and large losses at that point. The question is, how robust or again if you're a central bank that oversees a bank or an insurance company, how robust are they to those developments?
With climate, one of the biggest systemic risks is actually the transition towards a more sustainable economy. It sounds a bit like a paradox, but the fact is that if that transition is smooth and predictable, then market functions well, certain assets are gradually retired, lower carbon assets come into play and the banks and other financial institutions adjust. If it's a delayed in quite abrupt transition, then you will end up with stranded assets and large losses at that point.
Carney: The other area though, which some central banks are looking at is, in terms of their monetary policy and liquidity operations. The ECB is looking at this, the Bank of England is now looking at this. How consistent is the collateral that they take for those operations, with the transition towards net zero and if it's not consistent, what do they do about it in a way that is as market neutral as possible because as you know, in general central banks are trying to be market neutral, but in some jurisdictions it's not uniform. There is this overlay in terms of climate.
Beckworth: Do you envision central banks, for example, buying green bonds or using their balance sheet space to support that transition?
Carney: I think the issue is this, which is as a central bank you need to be able to take collateral against a broad range, whether it's for asset purchase reasons or providing liquidity against collateral. You need a reasonably broad range of collateral. Only to buy green bonds, it's still a relatively small proportion of the market. What you need to be able to do as the central bank, in my judgment, is to provide liquidity or buy assets that are part of the transition. It's not just green. You're going from brown to olive, to light green, towards kelly green and you need a richer taxonomy around that, which is being developed, but doesn't fully exist. That's one of the challenges that needs to be addressed in order for the central bank to be able to fulfill its core responsibilities and if it's in a circumstance where it has this overlay to do it.
Carney: Let me just be clear. This is not about a central bank reading into its remit some new responsibility. In the UK, the chancellor has written to the committees, directed the committees for the supervision of the banks, for the macro prudential and the monitoring committees, you must take climate change into account. That's an explicit direction. What they're doing is they're working through exactly how they do that.
Beckworth: In the case of the United States, the Fed has a very narrow mandate. Do you foresee challenges for the FED going down that path?
Carney: Well, I'm sure the FED, as it always does, will stay clearly within its mandate in this regard and a number of governors have spoken about these issues. The FED of course is the supervisor in the Federal Reserve system supervisor to some of the world's largest financial institutions and financial institutions across the board. These are real risks and this transition, if it's going to succeed, will proceed relatively rapidly. As the supervisor, any central bank who is a supervisor, you want to make sure that your firms have a strategy that's resilient, that they're taking these risks seriously, that it's overseen at the right level of the board, that they understand the data and other aspects around those risks. I'm sure the FED will play in that regard. It's a different thing though. Let's not say monetary policy is determined by it because it's a longer term structural …
Beckworth: Right. As you mentioned, you just want to have that portfolio of assets that reflects the transition's already going on in the economy toward a greener, cleaner system. Just let's switch from the central banks into the finance system more generally. What concrete steps should we be taking so that it supports this transition?
Carney: I think the first thing, so we need information, we need tools, we need markets and we develop all of those. Markets don't function well without the right information, so one of the things we've been doing is getting climate disclosure. It's robustness and resilience of its strategy to that transition towards climate and towards physical climate events. For some, it could affect the supply chain, for others it's the competitiveness of their products or services as a price on carbon increases or fuel standards change or other certain regulatory aspects that come into play.
Carney: That's something called the TCFD, which is the gold standard for that disclosure and there's a process globally implementing that type of disclosure, so that it's clear, it's comprehensive, it's consistent across jurisdictions and the market can take a view. People in the market can take a view of who's going to be competitive going forward in this environment and who isn't. By the way, that view in a market will also be influenced by what people think will happen with climate policy. Whether there'll be big infrastructure spending or a price on carbon or some other regulation. The market will be a market. Markets need information. This is a core driver of value and they don't have that information yet, so we need that to be in place.
Carney: On the other side of the ledger, there are some new markets that need to be created to be of a standard of other markets. You hear a lot of information or headlines around carbon offsets, for example. Do I plant trees to take carbon out of the air? Do I get a benefit if I have a new renewable in an emerging economy, et cetera? That market, for all the headlines, is tiny. I mean, it's measured in the hundreds of millions of dollars. In a true transition, this is a $100 billion a year market. There's a big process that's underway to put in place the plumbing and the governance, the standards for a global market in carbon offsets, which we will see move forward, probably by the end of the year, so that's a pretty exciting development.
Carney: Third thing and I'll stop on this, which is for the financial institutions themselves, what's their trajectory? What's their carbon footprint, of the people they're investing in or lending to and how do they expect to manage that going forward? Do they have a transition towards net zero? How much sustainable finance set another way are they going to do? As I mentioned a moment ago, we have some of the world's biggest institutions, many of which are headquartered in the United States, who voluntarily stood up and said, we're going to manage to net zero by 2050. Actually, we're going to have specific targets by 2025 and 2030, so you can measure the short term. They don't say this quite as loudly, but what they're also saying and thinking and we're going to make a lot of money off of this because actually this is the way the world's headed. I'm not sure exactly when we get there, but to be carbon competitive is going to be value created.
Beckworth: Do you foresee any challenges over what we define as green or the appropriate transition? What comes to my mind would be like, I would think personally we would include nuclear, geothermal, but there are some who would say no, no, no to that. Do you see any issues on that front?
Carney: There are issues on, first thing to say on the technology side is we need a host of different technologies in order to truly get to net zero. It could be nuclear, it could be small modular nuclear reactors and certainly geothermal can play a role, as does solar. Ultimately for many applications, think about steel and others, need hydrogen to be able to use hydrogen at scale. There's the host of technologies, some of which are economic today. Solar, wind as two great examples. Others which you can see becoming economic by the end of the decade at the latest, probably maybe earlier, which is some of the hydrogen technologies, carbon capture and others. Then others which may take a little longer, but still need to becoming. I think there's a host of technologies.
Carney: What we need and this is something we're working on is, to use Carville's line, is the transition stupid? It's about a transition. We can't just jump overnight to the green nirvana. It's about making progress, reducing emissions, with a series of technologies and investments over time. We need disclosure that reveals that, we need a way of aggregating that and talking about it that fairly represents where we are in this transition and that's part of what's being developed for Glasgow in November.
Beckworth: Well, Mark, we are nearing the end of the show and I want to give you the final word here. Any parting thought?
Carney: David, well first, thank you for having me. It was a great conversation. I hope we get your nominal GDP targeting one day. I think the thing that links our conversation as helpful to bring it out is that, as we said, we're both big believers in markets and the value that can be created by markets. Markets exist in a bigger system and it's important to have that system right and to deliver what society values. Part of that, an essential part of that bigger system, is our central banks, the role of central banks. For monetary stability, for financial stability, for thinking through the future of money and delivering that future of money in a way that markets can do their jobs and of course, markets doing their job is ultimately about providing solutions and a better way of life for people.
Beckworth: Okay. With that our time is up. Our guest today has been Mark Carney. His book is Value(s): Building A Better World For All. Mark, thank you again for coming on the show.
Carney: Thank you very much for having me, David.
Photo by Geoff Robins via Getty Images