The European Central Bank headquarters in Frankfurt, Germany

The independence of central banks is under threat from politics

The Economist, April 13, 2019

That is bad news for the world

Critics of economics like to say that its abstract theories lack real-world pay-offs. There is a glaring counter-example: the global rise of central-bank independence in the past 25 years. In the 1970s it was normal for politicians to manipulate interest rates to boost their own popularity. That led to a plague of inflation. And so rich countries and many poorer ones shifted to a system in which politicians set a broad goal—steady prices—and left independent central bankers to realise it. In a single generation billions of people around the world have grown used to low and stable inflation and to the idea that the interest rates on their bank deposits and mortgages are under control.

Today this success is threatened by a confluence of populism, nationalism and economic forces that are making monetary policy political again. President Donald Trump has demanded that interest rates should be slashed, speculated about firing the boss of the Federal Reserve and said he will nominate Stephen Moore and Herman Cain, two unqualified cronies, to its board. Brexiteers rubbish the competence and motives of the Bank of England, while India’s government has replaced a capable central-bank chief with a pliant insider who has cut rates ahead of an election. And as we report this week, many top jobs at the European Central Bank, including the presidency, are up for grabs, and some could become part of a wider political struggle over who runs Europe’s institutions.

The problem of politicisation last became acute in the 1970s. After the post-war Bretton Woods currency system collapsed, central banks failed to tame racing inflation because politicians, who pulled the strings, were reluctant to bear the short-term cost of higher unemployment. Two decades of runaway prices and crises led to a new orthodoxy that central banks should be given operational autonomy to pursue an inflation target. In the euro zone, Japan and Britain central banks became legally independent in the 1990s. In America the White House refrained from even publicly discussing Fed policy. This consensus survived the crash of 2007-08 and is one reason why global inflation has been only 4% a year on average over the past two decades.

The fraying of central banks’ independence has several causes. One is populism. Leaders like Mr Trump combine the politician’s desire for low interest rates with a reckless urge to undermine institutions. Another is the scope of central banks’ activities, which expanded after the financial crisis. Most now hold huge portfolios of government bonds while at the same time policing the financial industry. And the record of central banks is far from perfect. Because they have probably been too hawkish the recovery from the crisis has been slow, undermining voters’ faith in the technocrats whose loyalty is supposedly to the public interest. All this makes it easier to view them as political.

Pressure is manifesting itself in different ways in different places. Mr Trump has launched an attack on the Fed. Although his legal authority to sack Jerome Powell, its chairman and a Trump appointee, is not clear, if he wins re-election in 2020 he will be able to nominate a new Fed chairman and two more governors. In Europe a flurry of job changes threatens to lower the calibre of decision-making at the ECB. By the end of the year, three members of the six-strong executive board and eight of the 19 national governors, who also vote on rates, will have left. The most notable of these is Mario Draghi, its head. His departure in October will happen almost concurrently with elections and a change in leadership at the European Commission and Council. Behind the political game of revolving chairs is a battle between countries to control policy.

It is right that the objectives and tools of monetary policy are subject to democratic scrutiny and that central bankers are accountable to legislatures. The Fed is reviewing its target in order to be prepared for a downturn. Other central banks should follow suit. In the long run, this secures their legitimacy and hence their independence. Yet in today’s political environment it is naive to think that politicians really want a considered debate. Instead, the more central banks are in the limelight, the more they will find their month-to-month decision-making subject to external pressure, or find themselves at the whim of boards packed with hacks. It is just that sort of politicisation that the theorists behind independent central banks wanted to avoid.