Economics in theory and practice

Speech by Mr Agustín Carstens, General Manager of the BIS, at Corvinus University, Budapest, Hungary, 17 March 2023.

Rektor Takáts, distinguished guests, faculty, students and members of the Corvinus University community.

It gives me great pleasure to accept the award of Doctor Honoris Causa from this prestigious institution. I would like to thank the nomination committee for the great honour.

This is the second time in my life that I have received a Doctorate.

The first was almost 40 years ago, at the University of Chicago. I earned that degree for my academic work, including a dissertation on the foreign exchange market for the Mexican peso.

Today's award recognises my post-academic career in policy institutions and international financial organisations, including the Bank of Mexico, the Mexican Finance Ministry, the International Monetary Fund and, most recently, the BIS.

Reflecting on these two awards, I would like to share some thoughts on the relationship between academic research and practice in economics.

A sharp distinction is sometimes drawn between these two aspects of economics, as if they were opposites; research here, practice there. At the risk of exaggeration, I would say that there is a perception that researchers dismiss the rigour of policy work, while economists in policy institutions despair at the baroque abstraction of some academic research. Certainly, in some graduate schools – although I know this is not the case at Corvinus! – students are told that they must choose one career path or the other.

This sharp distinction has always puzzled me.

I have built my career as a practitioner of economics. But that in no way implies that I dismiss the inestimable value of research or economic theory; quite the contrary. Researchers and practitioners share the same ultimate goal – to design policies that improve the lives of ordinary people. And I have always believed that both rigorous theoretical investigation and effective practical application are very much needed to achieve that goal.

At the end of the day, a virtuous circle must be created between theory, research and implementation of economic policies. And this interaction, this feedback cycle as it were, must occur at all stages of what I think of as the public policy life cycle. This cycle starts with the high-level conceptualisation of policies. It then moves to formalisation – determining the details of how policies can be applied to the real-world. The next stage is implementation, as policies are actually put into practice. Monitoring then follows to make sure that policies operate as they should, and evaluation to determine if they have achieved their intended objectives. As a final stage, based on that evaluation, policies must be adapted, which may in turn initiate a new stage of conceptualisation and design.

At each stage, a close interaction between theory and practice should be sought. Economic theory can, and in many cases has been, an inspiration for public policies. But policymakers must then translate theoretical concepts into feasible plans of action. This means taking account of the political environment, social needs, the complexity of the real world and practical constraints. At the same time, economic science cannot advance without learning from public policies that have been implemented. In some circumstances, practice advances faster than theory.

All this may sound quite abstract and theoretical. So, in keeping with the theme of my remarks, let me give you two practical, real-world examples.  

The first concerns inflation.

Inflation has re-emerged over the past year as the most significant macroeconomic challenge facing central banks. Its rise has been large, rapid and global.

Few saw it coming. Two years ago, most central banks – and other forecasters – expected that the Covid pandemic would add to the forces keeping inflation low. One year ago, inflation had risen, but was expected to be transitory. Today, we are experiencing the largest and most persistent global inflationary surge since the 1970s.

What did we get wrong? Undoubtedly, a series of large unforeseen shocks played a role: the pandemic, the surprising rebound that brought a very strong economic recovery, the Russian invasion of Ukraine. Also contributing were the enormous monetary and fiscal policy stimuli deployed early in the pandemic, which governments and central banks found hard to calibrate in the face of enormous uncertainty.

But there is clearly much that we still don't know about inflation. Researchers have been working hard to fill the gaps. Over the past year, BIS economists have laid out an alternative view of the inflation process, one that seeks to overcome some of the limitations of conventional analytical frameworks. This view sees the inflation process as two regimes – a low- and a high-inflation regime – with potentially self-reinforcing transitions from the low to the high one.

In my view, this work is intuitively appealing and goes some way towards explaining why inflation has risen so much over the past two years. But it is only a first step, and much more research is needed to give policymakers the insights they need to head off such inflationary breakouts in the future.

In the meantime, central banks cannot wait for definitive conclusions. They have had to act decisively to bring inflation down. In this way, policy is moving ahead of theory, teaching us lessons about the inflationary process, and monetary policy transmission in a high-debt environment, in a way that can inform future theory and research.

My second example concerns innovation in money and payments systems.

Here too, practice has run ahead of theory. In recent years, new financial assets have emerged, including cryptoassets and stablecoins that purport to be money. Meanwhile, in many countries, big techs have enlarged their footprint on the financial system, particularly in the sphere of payments.

As technology evolves, the public will demand more functionality from money. Notes and coins will not suffice. The public will demand money that is digital, programmable and capable of moving seamlessly across platforms and countries. They will be less tolerant of costly manual regulatory checks and sluggish intermediaries.

It is incumbent upon central banks to provide money that meets public needs and expectations. If they do not, then other, less trusted, institutions will step in to meet that demand.

The good news is that central banks are awake to the challenge. Many are already experimenting with more technologically advanced forms of money, including central bank digital currencies and tokenised deposits.

Let me emphasise: This does not mean that we want to get rid of cash. The point is just that central banks should be ready, in a given case, to meet society's demand for a superior technological representation of money.

The BIS is an active partner in these efforts. Our Digital Economy and Innovation team is working on a theoretical framework with the aim of mapping out a vision of the future financial system. Meanwhile, at our Innovation Hub, we are conducting practical experiments on the technologies that will bring us closer to realising this vision, including efforts to maximise the privacy of money.

I would encourage students and researchers – including audience members here – to join us in these efforts. Providing trusted and secure money and an efficient payments system is a basic requirement for economic growth and prosperity. If I were a student again, starting my career as a researcher today, or as a practitioner in a policy or financial institution, I can think of few topics more worthy of attention.

Thank you very much.