SLOWLY but surely, the case for central bank independence is being undone. It may not look like it, with central bankers being afforded even greater powers than before the recession, but we are probably at the high watermark of their influence and autonomy. At some stage, as it becomes clear that monetary policy has turned into fiscal policy, and when the full extent of the macro-prudential powers that have been granted to officials become apparent, there will be a backlash. The independent monetary policy committee was manageable in a democracy when it was confined to targeting consumer prices, as it was pre-2008 – the financial policy committee will be far more controversial from the start. Already, the government is inventing polices (such as credit easing or subsidies for 95 per cent mortgages) to counteract the tightening of its own regulators.
As a paper from the Politeia think-tank by Michael Bordo of Rutgers and Harold James of Princeton points out, the intellectual shift towards central bank independence over the past couple of decades was based on the view that their mission was to pursue a simple rule: minimise consumer price inflation. The problem is that this is no longer what they are being asked to do. Discretion is back, central banks are once again taking over financial regulation and monetary stability is much less of a political priority. Central banks now have to make choices about what types of securities to take into their portfolio; when there is a possibility of a loss, an implicit subsidy is involved. Combined with QE, central banks are now operating a quasi-fiscal policy. No wonder pressure for repoliticisation is mounting, especially in the US and EU.
Bordo and James don’t pull any punches. They worry politicians see monetary policy as a free lunch and increasingly wish to be able to influence to whom credit is allocated (to their constituents, rather than more globally). Bordo and James compare this to the interwar period when trade policy became nationalised, with disastrous consequences.
My own view is that it never made sense for central banks to focus on consumer price inflation – this obsession is what triggered the bubbles. One could still have independent central banks tasked with a more complex set of rules, aiming at controlling the growth rate of total liquidity in the economy. Such rules could have prevented the bubble, which was at its core a simple, old-fashioned case of central banks allowing or encouraging excessive monetary creation (and its corollary, credit). But central banks whose job it is to micro-manage the financial system or who – like the Bank did in October – bought £16.9bn in gilts at a time when the government issued £17bn, monetising the entire deficit, cannot remain independent.
If anything, today’s problem is even greater than that: it is clear from the global government debt crisis that fiat money – currencies entirely detached from any commodity or anchor and produced entirely at the discretion of government agencies – has failed. Its adoption has abolished all restraints on governments and has meant that currencies keep being devalued and inflated away. Eventually, we will need a new monetary system more in tune with the principles of capitalism and sound money – until then, expect tensions between central bankers and governments to rise and rise.
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