Central bank independence in the future


Over the past 30 years, most central banks across the advanced economies have been given the ability to conduct monetary policy independently from interference by fiscal and political authorities (Crowe and Meade, 2007). Today, almost all central banks in OECD countries are operationally instrument-independent, counting on their own tools to set or target several interest rates, even if none of them is goal-independent, since political bodies give them their mandate. Closely related to central bank independence has been the adoption of inflation targeting as a policy framework, whereby central banks announce their target for inflation in the CFM Surveynear or medium term, and transparently describe their different policy choices with respect to the target (Svensson, 2010).

Empirical work has measured independence using a variety of different indicators. The more commonly used include: (i) the rules for appointment and dismissal of the central bank governors (ii) the extent to which the government or fiscal authorities must be consulted before monetary policy decisions, (iii) whether the goals of the central bank are wide-ranging or tightly focused on what he central bank can achieve, and (iv) the ability of the central bank to finance its operations without relying on the government. More recent academic literature has also emphasized the importance of transparency and accountability of the central bank, the ability of the central bank to use its balance sheet, and the extent to which the central bank counts on fiscal backing and the rules for the distribution of its revenues (Reis, 2013). As a result, central bank independence is not a 0-1 outcome, but rather can increase or decrease in a more continuous fashion.

Question 1: Do you agree that central bank independence in the Eurozone and the UK will decline over the next 48 months?

Seventy panel members answered this question. The panel members are roughly evenly divided, with a minority of 32% that either agrees or strongly agrees, a larger minority of 45% that either disagrees or strongly disagrees, and a large fraction of 22% that neither agrees nor disagrees. Given that central bank independence has been largely uncontroversial for a long period, it is remarkable that a substantial fraction of our experts now think that there could be serious changes in central bank independence. [….]

However, times have changed and as pointed out by Pietro Reichlin (Università LUISS G. Carli), ‘since 2008, the ECB objectives have expanded from inflation targeting to financial stability, prevention of speculative attacks on sovereign debt, liquidity provision to national banks in peripheral countries and quantitative easing.’ Several panel members think that such changes will affect central bank independence. For example, Sylvester Eijffinger (Tilburg University) writes that ‘the unprecedented size of the central bank balance sheets in the Eurozone and the UK has far reaching implications for the financial dimension of central bank independence by the monetary financing of government debt undermining the credibility and independence of the central banks. The threat of fiscal dominance with monetary accommodation is particularly strong in developed countries (Eurozone and the UK) with high public debt levels.’

Question 2: Do you agree that the traditional argument that less central bank independence leads to higher inflation will (still) be relevant over the next 48 months in Western economies?

Seventy panel members answered this question. The panel members seem again divided with a minority of 34% that either disagrees or strongly disagrees and a larger minority of 48% that either agrees or strongly agrees. It is again remarkable that a proposition that has been taken for granted in the academic literature for quite a while can no longer count on a clear majority either. […]

Further arguments have been put forward for central bank independence over the years. Independent central banks are less prone to fund fiscal deficits via seignorage, which is the common harbinger of hyperinflations (Cagan, 1956). An independent central bank may be the optimal answer to the political economy equilibrium between different public policy bodies with different expertise and effect on income distributions (de Haan and Eijffinger, 2016). In the Eurozone, the independence of the ECB is tied to independence from national policymakers, and further arguments for it are that it is able coordinate policies across countries, and to internalize macro externalities across countries.

Question 3: More generally, do you agree that it is desirable to maintain central bank independence in the future?

On this normative question, the panel members responded with almost unanimity and great confidence. Of the fourty-nine panel members that answered this question, fourty-six either agreed or strongly agreed. Only one neither agreed nor disagreed, another disagreed, and a final one disagreed strongly.

Several mention the traditional argument that too much political influence will lead to expansionary policies that lead to higher inflation and at best some short term increase in real activity. As Michael McMahon (Warwick) writes: ‘…monetary policy independence should be maintained to avoid concerns that that government is trying to regain control of monetary policy for such manipulation.’ Francesco Lippi (Università di Sassari) points to the difference in horizon as a fundamental reason why independence must remain: ‘CB independence is useful because monetary policy decisions are for the medium run, an horizon for which the typical policymakers are not well equipped. The CB ex-post accountability ensures the process remains ultimately accountable to the citizens.’