There was a time, not that long ago, when central bankers were the lapdogs of presidents, prime ministers and finance ministers. The banker would be invited over for a coffee and leave knowing the government would not be upset in the slightest if he were to drop interest rates. The casual meetings typically happened ahead of elections, and damn the inflationary consequences.
Today’s central bankers, at least in the Western world, Japan and a few other big economies, enjoy independence and power that was once unimaginable. Immune from politicians’ cynical desires, they set interest rates without interference. When the economy falls apart or inflation gets too low, they are allowed to do funny things like buy trillions of dollars of bonds, drop interest rates to zero – negative if necessary – and flood the private banks with cheap loans. The theory is that, since central bankers don’t need to buy votes, they can be trusted to prevent runaway inflation and smooth out economic cycles.
It was all fun and good while it lasted. Today, central bankers’ independence is under threat and could be curtailed.
If Donald Trump had his way, the U.S. Federal Reserve would do exactly what he instructs it to do, namely drop interest rates to the point they boost the chances of his re-election. Central bankers aren’t blameless in making themselves targets. In some cases, they strayed into the political arena, or appeared to, opening themselves to accusations of mission creep from politicians and voters. They also proved that, in spite of all the fancy tools at their disposal, they’re not very good at preventing crises. Still, their independence is to be cherished. Mr. Trump’s casino and hotel businesses have filed for bankruptcy at least four times. Do you want him setting interest rates?
The golden age of independent central banking lasted roughly from the early 1990s until the 2008 financial crisis. During those years, growth was pretty strong and inflation rates were benign (generally between 2 and 3 per cent in the United States). In 1997, Britain’s new Labour government, under Tony Blair, made the Bank of England fully independent. A year later, the European Central Bank was established. Modelled on the Bundesbank, Germany’s well-regarded, inflation-busting central bank, its obsession was price stability and transparency.
The financial crisis broke the notion that independent central bankers were blessed with reliably astute judgment. In North America and in Europe, they failed to prevent the biggest asset bubble in history from forming. But once the financial system imploded, pushing economies everywhere into deep recession, they moved fast to repair the damage, though the ECB was slow off the mark. Interest rates came crashing down. Quantitative easing – the mass buying of bonds – was launched. Credit easing helped the banks stay intact. By 2010, the worst was over, though the ECB still faced a nightmare in Greece and Italy. In 2012, ECB president Mario Draghi’s pledge to do “whatever it takes” to save the euro from destruction worked its magic.
Still, the central banks’ swift moves were not enough to fully repair their images and a few central bankers took heat for allegedly straying too far from their core mandates. Many Germans have no love for Mr. Draghi because the ECB was a key player in three Greek bailouts. A lot of them thought that Greece was the author of its own misfortunes and should be pushed out of the euro zone. Germany is a country of savers and they dislike him today for pushing rates into negative territory, hurting their pension returns.
Bank of England governor Mark Carney, the former governor of the Bank of Canada, was accused of overreach by making speeches about the financial and economic dangers of a no-deal Brexit and rapid climate change. While he argued that his warnings were well within the bank’s remit, some said they were excessively dire and that he was, in effect, straying into the world of politics – a no-no for an ostensibly independent central banker. Jacob Rees-Mogg, the Conservative MP and arch Brexiteer, last year called Mr. Carney a “wailing banshee” whose Brexit warnings cannot be taken seriously, and that he was an “enemy of Brexit.”
In the United States, Jerome Powell has a rather more high-profile critic in the form of Mr. Trump, who has used dozens of tweets in recent months to attack the Fed chairman for not dropping interest rates swiftly (the Fed has made two quarter-point cuts since July, the first reductions in 11 years). In one furious tweet, the President wrote: “My only question is who is our bigger enemy, Jay Powell or Chairman Xi,” referring to Chinese President Xi Jinping.
The attacks on Mr. Draghi, Mr. Carney and Mr. Powell will continue. They need a strategy to preserve their independence, because handing monetary policy back to the politicians would be a disaster. Inflation in Britain reached 24 per cent at one point in the 1970s, when the notion of central bank independence was alien.
Erring on the side of political caution would be one good strategy. Although Mr. Carney’s Brexit and climate-change warnings were valid – both do pose risks to the financial system – they were interpreted as a display of his political colours, ensuring he would become a target. Best to remain utterly neutral, even if it means making endless speeches on the joys of fiddling with interest rates.
Finally, politicians need to realize that central bankers are not miracle workers. Empowering central bankers does not mean that fiscal policy – the politicians’ responsibility – can take a back seat to monetary policy, as it has in recent years. The two have to work together. You can’t strangle an economy with austerity measures and complain that central bankers have not done enough to boost inflation and growth. Unless central bankers fight back, their independence may be short-lived.