YOU occasionally read something that really sticks in your mind. For me, one such instance was in first-year macroeconomics at university, on the topic of the desirability of central bank independence. It was in a textbook by Greg Mankiw that concluded: “Central bank independence [from political pressure] appears to offer countries a free lunch: it has the benefit of lower inflation without any apparent cost.”
This result, in part, stemmed from the work of Alberto Alesina and Lawrence Summers, who found that more independent central banks were associated with lower and more stable inflation. This did not seem to come at the cost of real economic activity. There was no correlation between independence and unemployment or real GDP growth, for example.
Independence has, therefore, been conventional wisdom for the past decade. Without it, politicians would surely have a tendency to over-inflate, it is said, particularly as elections approached. And the recent IMF World Economic Outlook suggested that central bank independence had been a key factor in helping to anchor inflation expectations. Independence is said to enhance credibility in taking action to attain relative price stability.
Yet with Mark Carney just arrived at the Bank of England, it’s worth asking whether the age of central bank independence is coming to an end.
To some extent, this a moot question. In the UK, politicians decide on the Bank’s goal (price stability around 2 per cent on the consumer price index (CPI) measure of inflation). But HSBC’s Stephen King has put forward a compelling case that the independence central bankers do have is fading.
The chancellor, for example, has stated that his policy is for fiscal consolidation but “monetary activism”. Given that the Bank’s mandate is to try to keep inflation at target, it is unclear what “activism” should entail. Rather than focusing on the traditional goal of price stability, central banks seem under pressure to “do more” to propel the economy into a recovery – hence the use of the term “escape velocity”.
At the same time, as Ewen Stewart’s paper for the Centre for Policy Studies – Masking the Symptoms – explained, the Bank’s unconventional QE programme has created clear winners and losers: with pension funds losing out considerably, while governments have continued to be able to fund high deficits. CPI inflation has now been above target for over 40 months. Some may consider this an acceptable trade-off given the economic circumstances. But should these sorts of judgements be made by unelected central bankers?
Finally, the Bank now has responsibility for macroprudential regulation and financial stability alongside its inflation targeting function, with numerous instruments for meeting its different goals. But if central bankers have many different goals and instruments, some of which conflict, will politicians continue to give them free rein to make political choices?
In a democracy, independence is surely only justifiable if there are both divisions from the political process, and clear limits and accountability over the goals and instruments at the Bank’s disposable.
Ryan Bourne is head of economic research at the Centre for Policy Studies. @RyanCPS