Central banks: Peak Independence
Since the global financial crisis they have brandished new tools, such as the ability to purchase trillions in assets to prop up their economies, while acquiring deeper regulatory responsibilities over banks and markets. These freedoms have opened central bankers up to new criticisms, including claims they are hubristically attempting to tame the business cycle while storing up threats of bigger crashes down the road.
Their crisis-fighting interventions have also propelled these unelected technocrats into politically charged debates over income distribution and inequality. And they have left them operating on the perilous boundary between monetary policy and budgetary policy following the purchase of vast amounts of government bonds in “quantitative easing” schemes.
Until the crisis, it looked like they had hit on a magic formula. For much of the 1990s and 2000s leading economies enjoyed low and stable inflation, along with relatively steady growth in an era known as the Great Moderation.
Several central bank watchers believe the very notion of independence needs to be updated in light of the tools the monetary authorities have acquired.
The more powers and responsibilities central banks are given, the more they risk making politically charged choices, argues Stephen King, HSBC’s chief economic adviser. “A central bank is more likely to be perceived to have failed if it is burdened by a multitude of conflicting objectives,” he says. “The result is there will be demands for greater accountability to elected legislatures.”
In the US, the Fed faces a barrage of legislative challenges to its independence from Congress, where many lawmakers are troubled by its multi-trillion dollar crisis-era interventions. The proposals range from enhanced reporting requirements to more significant constraints on how the Fed conducts monetary policy and emergency lending.
While few of these initiatives are likely to become law, they come amid a polarised political climate that is proving treacherous for central bankers to navigate. Roger Lowenstein, author of America’s Bank, a new book on the Fed, says its political legitimacy is at its weakest in decades. “If the Fed had failed to effectively intervene and rescue the system — as was the case in the 1930s — you could understand why the Fed would be unpopular,” he says. “But in fact, the Fed is unpopular today because it did vigorously intervene.”
That scepticism has been reflected in Congress, where lawmakers have found that railing against the Fed is popular with their constituents. In 2013, the number of new congressional bills seeking to constrain the Fed outnumbered those empowering it by 45, a record margin, according to research by Sarah Binder and Mark Spindel in a forthcoming book on Congress and policy making.
In Britain the BoE’s cherished independence came under pressure during the recent Labour party leadership election, with Jeremy Corbyn, who won the contest, advocating that the central bank should be forced to fund government infrastructure — a policy called “people’s QE”.
John McDonnell, shadow chancellor, has since stated that central bank independence is “sacrosanct”. However, he has put together a group of experts, led by former BoE rate-setter Danny Blanchflower, to reconsider the mandate of the MPC, which primarily targets inflation.
“Independence is a good thing, but it is unclear whether, since 2005, the MPC has done better than the Treasury would have done,” Mr Blanchflower says. “Would a different remit [for the BoE] have made things different since the crisis? That’s not an unreasonable question to ask.”
Simon Johnson, a professor at MIT Sloan School of Management, draws a distinction between attempts to rein in the Fed’s discretion on monetary policy and possible reforms to its financial stability operations. Attempts by some Republicans to “clip the Fed’s wings on monetary policy” were a bad idea, he says. However, matters were different on the emergency lending side, where he argues there was insufficient clarity in the Fed’s own rules on interventions.
Last year, the BoE, which had come under attack for its handling of the crisis, sought to brush off its reputation for secrecy. The measures, which include publishing the minutes of MPC meetings alongside the decision instead of two weeks later, have been broadly welcomed. But critics fear that these plans do not go far enough, as they restrict the role official auditors would play in scrutinising the effectiveness of the BoE’s operations, for example.
The other area where central banks face pressure to display greater transparency is over their ties with the financial industry. The BoE has come under fire for allowing its newest rate-setter, Gertjan Vlieghe, to retain a passive stake in his former employer, Brevan Howard, a hedge fund that bets on the direction of interest rates. He has since cut his ties with Brevan, but lawmakers asked the BoE to review its code of conduct.
Beefing up the rules on accountability could go a long way towards ensuring that the public continues to trust central banks even as they assume new powers, critics say. Central bankers are already subject to extensive political scrutiny — for example in parliamentary hearings — but this may need to be broadened.
“Central banks have become supremely powerful and if power corrupts, absolute power corrupts absolutely. We need to be more innovative in designing accountability,” says Rosa Lastra, a professor of monetary law at Queen Mary University in London.
The answer may rest with the central bankers themselves, who need to stay above the political brawls to avoid complaints of over-reach. “Central banks should be fine provided they can truly explain everything they do in terms of stability, stability and stability,” says Sir Paul Tucker, former deputy governor of the BoE. “If they can do that, the public is less likely mistakenly to think of them as all-powerful agencies capable of solving all economic challenges.”
“There is a danger of central bankers talking too much,” says Lucrezia Reichlin, an economist at London Business School and a former ECB official.
“You should be careful about talking beyond policy, if you want to retain independence.”