Central Bank Independence

By | Updated July 7, 2017 5:50 PM UTC

After inflation ran amok in the 1960s and 1970s, many central bankers fought for, and won, more freedom to set interest rates and make other monetary policy decisions without political interference. Their shields began to crack after the 2008 financial crisis. In the years since the bankers deployed trillions of dollars to save the global financial system, the public’s faith in their work has been falling. Critics say independent central banks are too secretive and put commercial banks’ interests before taxpayers’, so it’s time for more public control. Central bank officials counter that they need to be free from political pressures to do their job of curbing inflation, promoting full employment and maintaining financial stability. But the “trust us” mantra is increasingly a tough sell.

The Situation

Central banks everywhere are struggling to stay above politics. In South Africa, the ruling African National Congress wants the bank, currently owned by shareholders, to become state-owned. And in June, the nation’s anti-graft ombudsman asked parliament to force the Reserve Bank to focus on the “socioeconomic well-being of the citizens” rather than on inflation. In the U.S., under the cry of “audit the Fed,” Republicans in Congress have proposed legislation that would subject monetary policy to review by Congress, reduce the Fed’s regulatory and emergency-lending authority and require policy makers to follow a formula for setting interest rates. U.K. Prime Minister Theresa May said the Bank of England’s policies widened inequality, and some politicians have called for more oversight of the central bank. The staff at the Reserve Bank of India complained of the government’s “unwarranted interference,” following a botched withdrawal from circulation of high-denomination bank notes at the end of 2016. Turkish President Recep Tayyip Erdogan repeatedly pressured the country’s central bank to cut interest rates. In recent years, central bank chiefs were ousted by presidents in countries including Algeria, Kazakhstan and Venezuela

The Background

The modern notion of central-bank independence evolved over time. Following the Great Depression, the U.S. Congress gave the Fed more power to set monetary policy. Still, it wasn’t free from political arm-twisting: Both Presidents Lyndon Johnson and Richard Nixon pressured Fed chairs to keep interest rates low. In the 1970s, Congress clarified the Fed’s mandate — to strive for maximum employment, stable prices and moderate long-term interest rates. Fed Chair Paul Volcker’s drastic efforts to curb high inflation helped cause the recession of 1981-82 and attracted fierce criticism — but soon brought prices under control and set the scene for steady economic growth. As a result, the case for central-bank independence gained ground elsewhere. The Bank of England was granted operational independence in 1997. And the European Central Bank, created in 1998, was independent from the outset because it oversees interest rates for all countries sharing the common euro currency. But lately there’s been movement in the opposite direction. The Bank of Japan agreed in 2013 to coordinate policy with the government, a move some called an alarming attack on its independence. Most of the attacks on the Fed stemmed from the financial crisis. It was blamed for failing to foresee and prevent the meltdown, and for its later role in bailing out some of the very financial institutions that contributed to the disaster.

The Argument

A widely cited 1993 paper by Alberto Alesina and former U.S. Treasury Secretary Lawrence Summers concluded that independent central banks are better at controlling inflation than central banks under political control. Shielded from pressures of day-to-day politics, the paper noted, they can make unpopular decisions and take a longer view. The Fed’s Yellen has restated this case in testimony to Congress. Supporters of the current Fed arrangements add that reports to Congress and financial audits by the U.S. Government Accountability Office provide plenty of oversight. Nobel laureate Joseph Stiglitz has argued that economies with independent central banks don’t always do better in financial crises. Besides, he’s said, “all public institutions are accountable, and the only question is to whom.” As central bankers have turned to new tools like bond-buying to juice their economies, they’ve taken on more of the roles that normally fall to lawmakers and government spending. The broader their tasks and the wider the effects, the more politics is bound to intrude — and the harder it will be to leave central banking to the central banks alone.

The Reference Shelf

  • The Federal Reserve Bank of Kansas City published a history “The Balance of Power: The Political Fight for an Independent Central Bank, 1790-Present.”
  • An op-ed by Senator Rand Paul in Bloomberg View: “Why I Want More Thorough Fed Audits.”
  • The European Central Bank explains its political independence and its practical implications. 
  • A 2014 study in the International Journal of Central Banking of more than 100 central banks found that there’d been a general trend toward greater independence over time. 
  • In a speech on the global battle over central bank independence, James Bullard, the president of the Federal Reserve Bank of St. Louis, said there was a “creeping politicization of monetary policy.”
  • A Bloomberg QuickTake Q&A explains why South Africa’s central bank is under fire. 

First published Feb. 15, 2017

To contact the writer of this QuickTake:
Christopher Condon in Washington at ccondon4@bloomberg.net

To contact the editor responsible for this QuickTake:
Anne Cronin at acronin14@bloomberg.net