The job of central bankers is to maintain the value of a currency by keeping inflation under control. To this end, many of them are immune to political pressure from governments.
This independence, once a sacred cow in the Western world, has come increasingly into question in recent years as central banks backed governments as they were hit by the global financial crisis and then the coronavirus pandemic.
Here are some questions and answers on a topic that is rapidly moving from academia to the political realm and could dramatically affect inflation in the coming decades.
What is happening?
Liz Truss, the front-runner to become Britain’s next prime minister, has promised to review the Bank of England’s mandate – possibly including its ability to set interest rates without government interference.
It came after the Bank of England on Thursday raised interest rates by the highest rate since 1995, while also predicting a prolonged recession and double-digit inflation – a double whammy for home finances.
Bank of England Governor Andrew Bailey is not alone. Central bankers around the world are under fire from politicians for failing to predict and prevent the current wave of high inflation.
What is independence from the central bank and why is it important?
A central bank is independent if it can set policies, such as setting interest rates or printing money, without interference from elected officials or the private sector.
The idea is that governments will lean on the central bank to fuel prosperity when they need to be re-elected and block interest rate increases that could be too painful for their constituents.
As a result, the economy will overheat and inflation will rise to an unavoidable degree.
Instead, central bankers should turn their attention to inflation, which is sometimes linked to another goal such as full employment, and let politicians deal with issues of redistribution and equity.
Is he working?
The data shows that central banks that were more independent, such as those of Germany, Austria and Switzerland, had lower inflation rates between 1970 and 1999 than central banks that were more closely linked to their governments, such as the governments of Norway, New Zealand and Spain.
But this relationship weakened in the new millennium, when new forces emerged, such as increased globalization and the introduction of the euro.
However, the alternative is difficult to digest.
In Argentina, where the central bank is tightly controlled by the president, inflation is close to triple digits, the peso has lost half its value in less than a year and a half and citizens face restrictions if they want foreign currency. Buying or selling goods abroad.
Are most central banks independent?
Most central banks in the developed world and many in emerging economies are formally independent, albeit to varying degrees.
In practice, the line between central banks and governments can be blurred, in some cases little more than polite fiction.
Turkey’s central bank is officially independent, but that did not stop the country’s president, Tayyip Erdogan, from firing one governor after another if he did not comply with his wishes.
Even in the US and Europe, central bankers are systematically accused of banking nations of making massive purchases of sovereign debt, which has become common since the global financial crisis.
While these “quantitative easing” programs are almost always justified by the need to raise inflation when it is too low, it means that central bankers are working alongside, rather than an arm, with their governments.
Nowhere has this been more evident than in Japan, where the central bank owns half of the national debt.
Has independence from the central bank always been the norm?
No, until recently central banks were the arm of the government.
The idea of a fully independent central bank was discussed in 1962 by economist Milton Friedman, who rejected it on the grounds that it would not survive its first “real conflict” with the government.
The Federal Reserve has enjoyed operational independence since 1951, but presidential interference continued at least until the 1970s.
Then-Fed Chairman Arthur Burns was under pressure to keep politics loose to help US President Richard Nixon win re-election.
The period that followed high inflation, which was caused by an oil shock that Burns Fed tried to mitigate, reinforced the idea of central bank independence.
This idea took off in the 1980s and flourished in the 1990s, when many central banks, including the Bank of England, were reformed, and more were created in what was formerly the Eastern Bloc.
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