Just as US President Donald Trump looks to nominate two political loyalists to the Federal Reserve’s Board of Governors, so too, how free central banks are from political meddling was a key theme on the sidelines of the International Monetary Fund meetings over the weekend in Washington.
Trump, for sure, seems unhappy that the Fed under the chairman he chose, Jerome Powell, raised interest rates. Had it not “mistakenly raised interest rates,” he tweeted on March 29, US gross domestic product and stock prices “would have both been much higher.”
European Central Bank president Mario Draghi has taken the rare step of commenting on the hot debate over whether Trump is undermining the Fed’s independence. At the IMF meeting, Draghi said he was “certainly worried about central bank independence” and especially “in the most important jurisdiction in the world.”
Also on Saturday, IMF chief Christine Lagarde said that for such institutions, “independence has served them well over the course of time and hopefully will continue to do so.”
The 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.
The case for central bank independence, however, has gained ground elsewhere. The Bank of England was granted operational independence in 1997. And the ECB, which oversees interest rates for all countries sharing the euro currency, has been independent since its creation in 1998.
But in recent years there’ve been moves 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. In December, 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.
Central banks in Pakistan, Russia, Nigeria, South Africa, Thailand and Turkey have also been pressured by politicians in recent years.
In July, Trump began criticising the Fed’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.
Independent central banks are seen better at controlling inflation with a longer-term view of the economy than those under political control. But 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 prop their struggling economies, they’ve also taken on more of the roles that normally have fallen to lawmakers and government spending. But the broader their tasks and the wider the effects, the more politics is bound to intrude.
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