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opinion

At an international symposium on central bank independence in Sweden last week, Federal Reserve chair Jerome Powell had a simple message for the high-powered audience about what monetary policy makers should do to preserve their freedom from political meddling.

“We should stick to our knitting,” Mr. Powell said.

“It is essential that we stick to our statutory goals and authorities, and that we resist the temptation to broaden our scope to address other important social issues of the day. Taking on new goals, however worthy, without a clear statutory mandate, would undermine the case for our independence.”

The mere existence of the event – organized by Sweden’s central bank and attended by a who’s who of monetary policy thinkers, including the heads of four G7 central banks – would have been hard to imagine a few years ago. Central bank independence was more or less a given, at least among the world’s advanced economies.

But that independence is being challenged by critics and political opponents precisely because they failed to do the one thing they were entrusted to do: control inflation.

If central banks are going to restore the public trust that they know what they’re doing and should be left alone to do it, the best way to do so is to recommit to that sole priority – even if it means turning away from other worthy social goals that central banks have felt increasing pressure and desire to address in recent years. The COVID-19 pandemic and its economic aftermath have demonstrated that “knitting,” as Mr. Powell called it, requires more singular focus than many monetary policy makers had come to believe.

Former Bank of England governor Mervyn King argued at the symposium that the rise of truly independent central banks in the 1990s was a consequence of an “an intellectual mistake” of monetary policy in the 1970s: that it could and should be used to minimize unemployment, in exchange for “tolerating a somewhat higher rate of inflation.” The painful stagflation that followed, he said, convinced governments that they needed to both commit to low and stable inflation, and to assign the job to independent central banks, who would be left alone to shoulder the politically unpopular task of raising interest rates to clamp down on inflation.

The combination of central bank independence, with a narrow, government-sanctioned focus on inflation targeting, worked very well for about a quarter-century. In fact, it all worked so well that we became used to low and stable inflation, with low and stable interest rates. It looked like central banks had successfully defeated inflation once and for all.

With that war won, many policy experts began to ponder whether central banks could achieve more. Central bankers asked the same questions of themselves. Increasingly, we have seen central banks – in Canada and elsewhere – talk about using monetary policy to maximize employment; to fight climate change; to reduce income inequality; to promote healthier housing markets.

Arguably, this combination of hubris about their ability to keep inflation under control, and a growing desire to stretch central bank mandates beyond inflation control and into new areas of social good, contributed to central banks’ late response to the inflation build-up in 2021 and into 2022.

Consider that even as the inflation rate first exceeded the Bank of Canada’s 1-to-3-per-cent target band in the spring of 2021, the bank was stressing the need to pursue an “inclusive” recovery from the COVID-19 recession – with an eye on the unequal effects of the pandemic. Bank officials signalled that they were willing to let inflation run a little hot, if it meant that more of the people hurt most by the pandemic were able to get back on their feet. In late 2021, the bank and the federal government even agreed to a new mandate for the bank that embedded the pursuit of “the maximum sustainable level of employment” into the monetary policy framework.

Meanwhile, Bank of Canada Governor Tiff Macklem assured Canadians that the bank could rein in inflation when it decided it was time. “We have the tools and we know how to control inflation,” he said.

What we’ve witnessed in the year or so since is stark evidence that it’s not so easy.

Central banks did allow their eyes to drift off the bottom-line objective of inflation control, if only for a while. We’re living with the consequences. And central bankers themselves are living with the difficult task of repairing seriously damaged trust among the public and elected officials – a trust they absolutely need in the future to be able to continue to do their job effectively and independently.

For Mr. King, it’s a reminder of why we sought independent monetary policy in the first place.

“Nobody would ever create a central bank to prevent pandemics. Nobody would ever create a central bank to combat climate change. They would create a central bank to try to ensure price stability. And they would create a central bank in order to try to maintain stability of the financial system.”

The lesson, he argued, is that central banks work best and are most trusted with their independence when they stick narrowly to those foundations.

“Only do what only you can do,” he said.