Central bank independence

After inflation ran amok in the 1960s and 1970s, many central bankers fought for, and won, more freedom to control interest rates and set 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 fading. 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 containing inflation, promoting full employment and maintaining financial stability. But the “trust us” mantra is increasingly a tough sell.The SituationCentral banks everywhere are struggling to stay above politics. This month, the governor of the Reserve Bank of India resigned just weeks after the government moved to exert more control over the RBI’s regulatory powers and how to use its excess capital. In July, US President Donald Trump began criticising the Federal Reserve’s interest-rate increases, breaking with more than two decades of White House tradition of avoiding comments on monetary policy out of respect for the independence of the central bank. Trump has blamed the Fed for stock market declines and in November said that he was “not even a little bit happy” with his choice of Jerome Powell to head the bank. In Turkey, President Recep Tayyip Erdogan, who holds the unorthodox belief that high interest rates cause rather than curb inflation, has repeatedly called on the central bank to restrain borrowing costs. Central banks in Pakistan, Russia, Nigeria, South Africa and Thailand have also been pressured by politicians in recent years.The BackgroundThe modern notion of central-bank independence evolved over time. Following the Great Depression, the US 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 chairman Paul Volcker’s drastic efforts to curb high inflation helped cause the recession of 1981-82 and attracted fierce criticism and even, as he reveals in his new book, an order from Ronald Reagan’s chief of staff not to raise rates ahead of the 1984 election. (Volcker left that meeting without saying a word.) Volcker’s efforts were ultimately credited with bringing prices under control and setting 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, which oversees interest rates for all countries sharing the common euro currency, was independent starting from its creation in 1998. But in recent years there’s been movement in the opposite direction. In the US, the Fed has been blamed for failing to foresee and prevent the financial crisis and for bailing out some of the very financial institutions that contributed to the disaster. The Bank of Japan agreed in 2013 to co-ordinate policy with the government, a move some called an alarming attack on its independence.The ArgumentA widely cited 1993 paper by Alberto Alesina and former US 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 take a longer view and make unpopular decisions to get there. Supporters of the current arrangements add that the Fed’s reports to Congress and financial audits by the US Government Accountability Office provide oversight. Nobel laureate Joseph Stiglitz has argued that economies with independent central banks don’t always do better in financial crises. As central bankers have turned to new tools such as bond-buying to juice their economies, they’ve taken on more of the roles that normally have fallen to lawmakers and government spending. The broader their tasks and the wider the effects, the more politics is bound to intrude.