Otmar Issing: Should we have faith in central banks?
Speech by Professor Otmar Issing, Member of the Executive Board of the European Central Bank,
held at St Edmund’s College Millennium Year Lecture, Cambridge, on 26 October 2000.
"Ultimately, trust must be earned, it is granted temporarily, it must be checked, and
it must be backed up by hard evidence, not be based purely on faith or belief."
"...A third aspect of faith relates to “keeping a promise” or “engagement” as in “acting in good faith”, in the sense of reflecting “honesty of intention”. For Thomas Hobbes “to have faith”, “to trust” and “to believe a man” are synonymous. One could think of this dimension of faith as representing a twosided relationship, rather than a unilateral act of faith.
From this perspective faith - or here better: trust - is similar to a contract established between two parties. The faith that the public places into the central bank imposes a constant obligation on the central bank to honour this trust and fulfil the promise of stable money. The bond of trust between the public and its central bank can be seen as something like a credit relationship. Indeed, the term “credit” is Latin for “he believes”, i.e. it expresses the hope and expectation that initially one-sided trust will be reciprocated and returned in the future. Trust is given “on credit” but in turn it is based on credibility or trustworthiness..."
"2. Trust: the role of money and the value of price stability
One does not have to look very far in order to find a link between faith and money. In fact, every onedollar bill bears the inscription “In God we trust”. The Euro will be more secular in this respect. In the case of Sterling, the pound notes feature a “promise to pay the bearer” of the note the amount stated. This points to the very nature of money as being built on trust, on a promise. Trust is crucial for money to function as a medium of exchange, as a store of value and as a stable unit of account. Using economic terminology, money - or rather the trust that underpins the use of money - has public good characteristics or confers positive network externalities on all participants in the economy. In this way money economises significantly on the costs of transactions that would be present in a pure barter economy.
If you look more closely at the dollar bill, you will find a further inscription which states “This note is legal tender for all debt, public and private”. This imposes an obligation to accept the note in the settlement of contracts and highlights the fact that money derives its value - whether imposed by a legal tender requirement or not - from the willingness of other economic agents to accept it to settle transactions. Each agent will only accept money, if he can be confident that it will in turn be accepted by other agents in future transactions. Thus money is a social achievement as has long been recognised by economists for example by Menger. Money is a question of trust, its use requires trust and it reflects trust. This is especially true in the case of fiat money, i.e. the use of printed paper - which has no intrinsic worth - as a medium of exchange and as a store of value. Yet even commodity money requires trust and a well-founded expectation that it will be accepted for a wide range of transactions. Milton Friedman, in his book Money Mischief (1992), reports the well-known story of the monetary system of a small island in Micronesia which at the end of the 19th century used stone wheels as a medium of exchange and as a store of wealth. He recounts an episode when the colonial government imposed “fees” on disobedient district chiefs simply by painting black crosses on these stone wheels. This miraculously and promptly induced them to change their ways just in order to have these marks erased again and thus - in their perception - their wealth restored. Friedman concludes that this example illustrates “how important appearance or illusion or “myth”, given unquestioned belief, becomes in monetary matters. Our own money, the money we have grown up with, the system under which it is controlled, these appear “real” and “rational” to us. Yet the money of other countries often seems to us like paper or worthless metal, even when the purchasing power of individual units is quite high.”.."
"...In order to hold and accept money economic agents must not only be confident that money remains accepted as a medium for exchange, but also be confident that money will retain its value over time, thereby ensuring that price signals can provide accurate guidance for markets to function efficiently. In contrast, if money loses its value, this also undermines its usefulness for exchange...."
"...Can we trust central banks and can we expect them to be credible in making good on their promise of
There is today a broad consensus that stable money is too important to be left to the day-to-day political process, which inevitably will always have to balance different objectives, conflicting interests and short-term pressures. If stable money is regarded as a common good for the benefit of all and if it is seen as a precondition for long-term prosperity and social justice then it makes sense for society to create an independent institution that stands above the fray of day-to-day politics and can pursue this objective with minimum distraction. This is the basis for central bank independence....
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