The last few years have been tough for adherents of the doctrine that central bank independence is crucial for maintaining stable prices. Three to four decades ago, the world went through a major push – partly predicated on the track record of Germany’s Bundesbank – to make central banks around the world independent of government policies.
The 2007-08 financial crisis, the Covid-19 outbreak and now the war between Russia and Ukraine have complicated the task. These institutions’ lacklustre performance in first spotting and then controlling the inflationary surge of the last few years has weakened the claim that independent central banks are better at stabilising economies – and hence political systems – than elected governments.
In many jurisdictions – including the UK, Australia and continental Europe, where latterly the National Bank of Poland has faced scrutiny – central banks have come under pressure. The charges fall under two main categories and are partly contradictory.
Central banks have been told they carried on monetary easing for too long before realising that the allegedly ‘transitory’ 2021 inflation uptick represented a more durable problem. In the aftermath, they have been criticised for tightening money too severely, precipitating slowdowns in some countries and making life difficult for over-indebted governments.
As a result of these policy fluctuations, many central banks face large losses on their balance sheets. These have been caused by the effect of interest rate tightening in greatly reducing the value of massive amounts of bonds purchased during previous bouts of quantitative easing. These shortfalls may force some central banks to seek financial support from governments, which could constrain their freedom of action.
There have been plenty of warning signals. Professor Charles Goodhart of the London School of Economics, a founder member of the Bank of England’s independent monetary policy committee in 1997, has been telling central bankers for years that they need to enjoy their freedom while it lasts. His thesis is that, faced with a conflict between hiking interest rates to counter inflation and adding to default risks faced by indebted governments, central banks will bow to political pressure and retreat from their price stability mandates.
An OMFIF report produced with EY in 2012, ‘Challenges for central banks: wider powers, greater restraints’ foresaw that central banks would run into conflicts. This reflected the widening of their mandates into areas like banking supervision or countering climate change, beyond Bundesbank-style sole concentration on price stability. In the report Stephen Cecchetti, then head of the monetary and economic department of the Bank for International Settlements, underlined the central banks’ dilemma: ‘As they are given more responsibility they may end up with less independence.’
Full independence throughout EU
In the European Union, the statutes of all central banks – including in countries which stayed outside the euro – were adjusted to a position of full independence more than two decades ago. This was the required prelude to establishment of the European Central Bank (owned by the EU’s national central banks) in 1998 and the start of economic and monetary union in 1999. As a result, the ECB and its shareholders enjoy constitutionally enshrined independence outstripping that in other countries.
Independence can breed conflict. The early history of the Bundesbank, whose independence from government dates back to 1948 when West Germany was under allied occupation and had no government, is punctuated with episodes where the central bank ended on the winning side in tussles with successive chancellors. In recent decades, the administration has gained the upper hand.
Four of the six Bundesbank presidents since the 1970s left their jobs before the end of their statutory terms as a result of tension with government. Only some of these elements of discord were publicised at the time. The most famous, Karl Otto Pöhl, who resigned in 1991, was embroiled in a series of furious rows with Chancellor Helmut Kohl.
More recently, the governors of the Bank of England and Reserve Bank of Australia both faced strong attacks from their governments last year. Turkey, with one of the most volatile economies in Europe, has had six central bank governors since the start of 2016.
Political considerations have had some marginal influence on interest rate decisions by the Federal Reserve, the world’s premier central bank, in the past few years, notably in the decisions to go slow in monetary tightening in 2021. But the Fed’s ability to raise interest rates strongly since March 2022, while at the same time remaining above the political fray, has contributed greatly to preserving the sanctity of central banking independence.
Importance of leadership positions
The virtually unassailable legal position of euro area NCBs has increased the importance of governmental decisions on their leadership. Poland has remained outside the euro. But the NBP’s legal independence, and the selection and powers of its president, are now the focus of a public dispute. This pits Donald Tusk, a former Polish prime minister now likely to return to the job after the country’s 15 October general election, against Adam Glapiński, the NBP president who has held the post since 2016.
The row has a strong personal element. Glapiński, an economics professor, was an adviser to former Polish President Lech Kaczynski, who died in an air crash in 2010. He is the twin brother of Jaroslaw Kaczynski, leader of the governing Law and Justice party, which finished without a parliamentary majority after the hard-fought October election contest against Tusk’s Civil Platform party.
Controversy over the NBP and the decisions of its nine-person monetary policy committee could be a distraction for Tusk. An intensifying dispute could detract from other pressing priorities and threaten the stability of the Polish economy at a difficult time. He faces the tasks of forming a three-party coalition, repairing the relationship with the EU, shoring up a faltering economy and safeguarding Poland’s position as a key Nato member deeply affected by neighbouring Ukraine’s war with Russia.
Central banks know they are steering a narrow path between constitutionality and competence. One well-known former European central bank governor related how he privately rented a flat in his home capital during his term of office, in case he decided to resign and relinquish his grace-and-favour apartment in a dispute over his independence.
Meghnad Desai, an economics professor and chairman of the OMFIF advisory council, gave a bitter-sweet description of the UK central bank’s prowess in the House of Lords in July (where he sits as a cross-bencher). ‘Independence of the Bank of England is all right, [but] what we need is competence. The Bank of England was more competent when it was not independent than it is now when it is.’ Ultimately, in an ever more complicated political framework, the benchmark for central bankers’ success or failure will be ability to fulfil their mandates.
David Marsh is Chairman, OMFIF.