Central Banks Must Be Rule-Bound, Not Independent

Retiring Senator Jeff Flake (R.-AZ), apparently concerned about President Donald Trump’s influence in all areas, wants legislation to make the Fed truly independent – of Congress as well as the President, presumably. However, independent central bankers like Ben Bernanke and Mark Carney have been responsible for most of the truly lousy monetary policy of the last two decades. Rather than mandating Fed independence, therefore, Congress must establish rules, constraining the Fed to observe monetarily responsible behavior.

The fashion for independence in central banking was a product of the 1980s and 1990s. Once Paul; Volcker had worked his magic at the Fed, and observers looked back at the bullying that had occurred between President Johnson and William McChesney Martin and to a lesser extent between President Nixon and Arthur Burns, it became clear that politicians could not be trusted not to inflate the money supply. Central bankers needed to be independent of politics.

Thus in 1998, as one of the first actions of the incoming Blair Labour government, the Bank of England was given full independence on monetary matters. Various emerging market central banks, for example in Brazil, were set up or re-established on the basis that local politicians could not be trusted. In New Zealand not only was the central bank made independent, but the Governor’s salary was set inversely to inflation so that the higher inflation rose, the lower his salary fell.

In retrospect, the diagnosis of those supporting independent central banks was wrong. Politicians are not necessarily pro-inflation; to the extent that there is a trade-off between inflation and unemployment, they may prefer unemployment to inflation, since inflation affects all their constituents whereas unemployment affects only some of them. You can see this in the EU, where politicians in countries like France and Spain have had very little inflation in recent years, but very high unemployment. The cause of the unemployment is generally excessive size of government and government meddling, but politicians generally love all that.

In any case, whether they are generally pro-inflation or anti-inflation, politicians are subject to frequent election campaigns, and therefore tend to keep the welfare of their constituents high if not uppermost in their minds. The same is not necessarily true of independent central bankers. If they are by profession bankers, they want to maintain good relations with the financial community, possibly with an eye to lucrative opportunities after their central banking service. If (as is more common) they are career central bankers or academics, they crave the respect of the economics profession and the financial media, neither of which constituencies have the welfare of the public much at heart.

1 2 3 4
View single page >> |

(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of "sell" recommendations put ...

How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.


Leave a comment to automatically be entered into our contest to win a free Echo Show.