Are central banks independent actors?
Just over a decade ago, the Bank of England was given full monetary independence from the British government, making it one of the last major central banks to achieve this status. The move was heralded as critical for maintaining confidence in the Pound and for removing political calculus from monetary policy.
But, fast forward to 2009 and the heralded independence of the BoE, along with that of its counterparts, the Federal Reserve in the United States and the Bank of Japan amongst others, is not to be take for granted. Monetary policy seems to have come under the influence of politicians once again. Is this good for the global economy?
To my mind, the move that marked the first inkling of what was to come was the nationalization of Northern Rock in the UK. Since that time, we have seen central banks act in concert in injecting liquidity, central bankers organizing around the clock meetings with government officials and bank heads to prevent crisis, and central banks acting in concert with the government to take over bankrupt institutions. The divide between central banks and government is virtually non-existent.
Bloomberg has a thought-provoking article on this very topic.
The global financial crisis is forcing the world’s central bankers to surrender some of their prized independence. Regaining it won’t be easy.
More than a principle is at stake. For longer than a quarter-century, independent central banks have been able to take painful and politically unpopular measures needed to restrain inflation. The worst economic calamity since the 1930s leaves Federal Reserve Chairman Ben S. Bernanke, Bank of England Governor Mervyn King, Bank of Japan Governor Masaaki Shirakawa and their colleagues under pressure to align policies with those of their nations’ elected leaders.
As a result, policy makers may find it harder to act whenever the time finally comes to begin soaking up the money with which they’ve flooded the globe.
“The lines between central banks and governments are becoming fuzzier,” says Nouriel Roubini, a New York University economist. “Inflation is the path of least resistance for politicians, but it is dangerous.”
Finance ministers and central bankers from the Group of Seven nations will discuss what more they can do together when they meet Feb. 14 in Rome. What’s brought them to this point is the collapse of credit markets, which has robbed traditional monetary policy of much of its punch.
The U.S. risks a deflationary economic decline — in which output, prices and wages all fall — even after repeated interest-rate cuts that have driven the overnight bank lending rate close to zero. In response, Bernanke has joined with the U.S. Treasury in unprecedented steps to revive credit.
Buying Up Securities
Meanwhile, King and Shirakawa, his British and Japanese counterparts, are set to start on the same course after seeking a go-ahead from their governments to buy up private-sector securities.
“Monetary authorities and the fiscal authorities are working hand-in-glove,” Canadian Finance Minister Jim Flaherty said in an interview.
While that may be necessary now, it could turn into a problem later. Some Fed policy makers have already stressed the need to move quickly, once the crisis passes, to sop up all the money they have pumped into the financial system. Critics charge that the Fed and other central banks laid the groundwork for the current turmoil by not raising rates fast enough once the 2001 recession passed.
The very next paragraph of this Bloomberg article quotes Tim Geithner, the new Treasury Secretary regarding his opinions on Fed policy.
“Treasury Secretary Timothy Geithner has voiced the opposite concern, noting that Japan in the 1990s and the U.S. in the 1930s snuffed out incipient recoveries by prematurely tightening credit. He has vowed not to repeat that mistake.”
But wait one second. Geithner is not a Fed official. He is the Treasury Secretary. This is a very telling passage because Geithner was the head of the New York Fed until he moved to Treasury. It suggests there is no independence at the Federal Reserve and that they have become one with the executive branch — a development, which I see as problematic.
Look back to the Bank of England saga. One reason New Labour came to power with the expressed desire to create independence for the BoE is that the previous government inserted itself into monetary decisions in a way that led to a bubble and severe crash that left the British economy in a deep recession in the early 1990s. Politicians are focused on the next election. Monetary policy must focus on the long-term health of the economy.
In fact, despite becoming a serial bubble blower later in his tenure, Alan Greenspan was much more independent as a Fed Chairman early on. George H. W. Bush blames independent monetary policy for his loss in the 1992 election. Clearly, this demonstrates the difference in perspective between central bankers and politicians. Contrast the BoE’s lack of independence with the Fed’s independence in the early 1990s and you see the end results.
The lack of central bank independence runs across a number of countries.
Other monetary policy makers are having their independence tested too. Iceland’s central bank Governor David Oddson is defying a demand from the new government to resign, accusing it of “little disguised threats.” Colombia’s central bank, pressured by President Alvaro Uribe over the past year to lower rates, will soon have a board composed almost entirely of his appointees when he fills two more seats.
“The deflationary environment is closing off options for central banks to act independently,” says Stephen Roach, chairman of Morgan Stanley Asia and a former Fed economist. “It’s very worrisome.”
Once lost, independence will not be easily restored.
Bank of England – Wikipedia
Central Banks Sacrifice Independence as Crisis Grows – Bloomberg.com