At a moment of increased government involvement in the economy, the solution we need might be a more independent central bank.
Politicians are not known for behaving unpredictably. When they do, it is usually for a reason. Thus when Germany’s Chancellor, Angela Merkel, publicly criticized three of the world’s leading central banks—the U.S. Federal Reserve, the European Central Bank (ECB), and the Bank of England—in a June 2 speech in Berlin, journalists and policy-makers around the world looked up and took notice.
It was not just that Merkel decided not to speak in the hushed, polite tones that politicians usually reserve for any discussion touching upon central banks’ conduct of monetary policy. Merkel’s Berlin speech drew attention for two reasons: first, her forthright criticism of the policies currently being pursued by the Federal Reserve and the Bank of England; second, her claim that the independence of some central banks, including the ECB, has been compromised as a result of political pressures.
It was, however, Merkel’s concerns about possible compromises to the independence of central banks that drew the most attention. “We must,” Merkel insisted, “return together to an independent central-bank policy and to a policy of reason, otherwise we will be in exactly the same situation in 10 years’ time.” Her position contrasts with that of other European centre-right leaders such as France’s Nicholas Sarkozy who, not long after being elected president in 2007, expressed the desire to diminish the ECB’s independence.
One of the financial crisis’ long-term effects will be to raise questions about central banks’ ability to maintain an independent monetary policy during periods of economic stress: that is, precisely when such independence is most important. Of course, no institution can be rendered completely immune from political and public pressures. But over forthcoming months, central banks are going to be faced with making decisions unlikely to please governments and legislatures worried about being reelected.
Though the Obama Administration has tried to avoid creating any public perception that the Federal Reserve is merely doing the Treasury’s bidding, it is unclear how the Administration and Congress will react when the Federal Reserve chooses to reduce the chance of future inflation by winding back some of the measures it has taken since the onset of the financial crisis last year.
The bigger political question, however, is the place of central banks in democratic political orders. Insulating central banks from excessive political influence reflects recognition of the truth that even in a democracy there are many public-policy decisions that should not be made by legislative or popular votes. Most democracies, for example, embody constitutional limits on the ability of governments and legislatures to interfere with the judiciary’s operations. This is usually derived from awareness that the common good normally requires some separation of powers in order to prevent excessive centralization of power.
The problem is that when it comes to the economy, governments have legitimate reasons for being concerned about and involved in the development of economic policy. This inevitably raises questions about how to maintain the autonomy of central banks and what ought to constitute the content of that autonomy. Governments committed to pursuing populist and socialist policies have no qualms about dramatically limiting or even abolishing such autonomy. This is why Venezuela’s Hugo Chavez has steadily eroded the independence of his country’s central bank, describing its autonomy in a 2007 address as a “neo-liberal idea” obstructing his long march towards “new socialism.”
In the end, it may be that the only way to protect central banks’ ability to conduct monetary policy in ways that truly insulate them from excessive political pressures and the distorting effects of internally incoherent legislation is to cut the links between them and governments.
One advantage of this approach is that the central bank would acquire a primary objective—monetary stability—uncomplicated by secondary goals or other state-mandated primary purposes. Another benefit is that the task of maintaining monetary stability would be even further insulated from direct and indirect political influences—if only to the extent that all other private businesses enjoy some protection from government pressures.
In the present political and economic climate, proposals for radically rethinking central banking are unlikely to achieve either popular or elite acceptance. Governments’ natural survival instinct during recessions is to try to augment their influence over monetary policy. This is especially true when governments are anxious to prove to economically-battered and politically-angry electorates that they are doing something, even if they themselves know that what they are doing is more than likely to have deleterious long-term economic consequences. But if we take seriously the advice of President Obama’s Chief of Staff Rahm Emanuel to “never let a serious crisis go to waste,” then now is as good a time as any to rethink the practices and institution of central banking.