Friedman, at least at the time he wrote, trusted neither of the two and advocated a constitutional rule for constant money growth as his preferred solution of the long-standing debate on “Rules versus authorities in monetary policy” (which is the title of the classic paper by Henry Simons from 1936). His concerns reflect what I would regard as a healthy distrust of the unfettered “rule of men” as opposed to the “rule of law” which he much prefers - in line with the long and venerable tradition of British liberal thinking. Friedman, at the time, was quite sceptical on central bank independence and asked whether it was “really tolerable in a democracy to have so much power concentrated in a body free from any kind of direct, effective political control?” This is why I believe it is important to stress that, if an independent central bank is assigned a clear and limited mandate, this represents a constraint on the discretionary exercise of power by the government but also by the central bank itself. In the absence of a complete and universally applicable rule for monetary policy an independent central bank which focuses firmly on the single overriding goal of price stability is the closest realistic and credible substitute for a literal “rule of law”. In particular such a central bank does not have the discretion to pick and choose at will among several objectives. A clear commitment to a single overriding objective is the key to credibility and it is also the key for accountability, i.e.
Using balance sheet policy, the central bank seeks to influence longer-term interest rates and thereby funding costs in a more direct manner. 3 Purchases of government or private sector bonds are intended to depress yields and push up securities prices – the so-called portfolio effect. 4 Studies from the past three or four years indicate that the portfolio effect has been in operation in both US and UK markets – bond prices have increased and long-term yields have fallen as a result of quantitative easing. 5 The aim is to achieve lower long-term yields in order to boost lending and investment. In addition to the portfolio effect, the new use of the balance sheet can have a signal effect: central banks that engage in large-scale purchases of securities to pull down long-term yields are sending a signal that the key rate may be kept low for a long period. In this sense, balance sheet policy also contributes to anchoring expectations and supporting monetary policy communication. It is not easy to say what the situation would have been without these measures. However, it is likely that central bank bond purchases have curbed the decline in output in the UK and the US. Chart: Central bank balance sheets, stylised These measures, by their nature, have an impact on central bank balance sheets – in terms of both size and composition. 2  See the Federal Reserve’s “Monetary Policy Report to the Congress”, February 2012, http:// www.federalreserve.gov/monetarypolicy/mpr_20120229_part1.htm.