Central Bank Independence — A Convenient Illusion

Professor Lars Syll writes:

Today’s model of delegation has much to recommend it. But it should not be cloaked in euphemism. It is an abrogation of democratic sovereignty for pragmatic reasons, conditioned on the one hand by deeply entrenched and unflattering assumptions about electoral politics and, on the other, on an unquestioning acceptance of the private organization of credit markets and their lack of confidence in democratic control of economic policy. This may be an abrogation that we are willing to accept, but it should be recognized for what it is and the assumptions on which it is based should be subject to scrutiny and, if necessary, to revision …

Independence of central banks was defined in relation to governments and the typical social interest groups of the corporatist era – trade unions and employers associations. But what about financial markets and their key actors?

How independent are central banks of the pressures of global finance? When it comes to financial crises their hands are forced. Central banks seem like hostages, or, eager collaborators of private finance … If independence was devised to guard against fiscal dominance, what it seems to have delivered in recent decades is financial dominance i.e. domination of central bank policy by financial markets …

For central banks to dig in their heels and insist that their only conceivable role is that defined by mandates shaped as part of a conservative counterrevolution half a century ago is not just small-minded or cautious. It is either an abdication of responsibility, a self-imposed immaturity, or, more ominously, a taking of sides with a dangerously unsustainable status quo …

The question bears repeating: independent from what? So long as the financial system retains its current structure, central banks are the hostage of crisis-situations that force their hand. Not just financial regulation, but structural change to the financial system should be seen as integral to the project of creating a more democratically accountable, truly independent central bank.

Adam Tooze

Central banks hold almost unrestricted power over monetary policies, policies that significantly influence inflation, employment, and economic stability. This power should be subject to greater democratic oversight to ensure it aligns with the interests of society’s citizens. Over time, central banks seem to have developed a kind of “policy bias” that prioritizes inflation control over unemployment and welfare, which appears deeply objectionable to large segments of the public.

For anyone who thinks that questioning central bank independence is some sort of typical heterodox view, I might remind you, as a historian of economic thought, that the originator of this idea — Milton Friedman — himself expressed doubts about the effectiveness of central bank independence, especially regarding its ability to consistently uphold sound monetary policy. Although Friedman generally advocated for monetary stability and was critical of arbitrary government interventions, he was sceptical that central bank independence would automatically lead to better outcomes. If nothing else, the last major financial system crisis (2007-2010) showed that Friedman’s doubts were more than justified.

There is also a deeper, fundamental issue here in how we view which decisions and considerations should guide us in socially and economically relevant policy issues. If, through a constitutionally and democratically established process, we decide to prioritize equity, welfare, and jobs over a set inflation target, it’s hard to see why we should be bound by an institution that imposes a more extreme ‘economic’ choice via a framework constructed for precisely that purpose. We must not forget that economics is NOT always a trump card in policy issues. This should be self-evident, but economists, in particular, often find it easy to forget. From an ‘economistic’ perspective, one might argue that it is more economically profitable to reintroduce geronticide rather than expand costly elderly care. But who would seriously advocate or accept something like that? Other considerations sometimes outweigh purely economic ones.

Beyond the democratic aspects related to the independence of central banks, there are also — especially in light of the striking failures to meet inflation targets over the past two decades — good reasons to question central bank competence. International research has also convincingly shown that the empirical evidence supporting the argument that independent central banks are beneficial to the economy is practically nonexistent.