Beware China’s attempt to erode central bank independence

Central banks should not become just another government department

Central banks’ independence from government enables them to fulfil their mandates of ensuring monetary and financial stability. But, in recent years, central banks have been subjected to mandate creep. The People’s Bank of China is one of the latest to face such pressure from its state.

The mandate creep for central banks started with an explicit financial stability mandate beyond the regulation and supervision of the banking system. How can a central bank ensure financial stability when markets have taken over the leading role of financial intermediation? The 2008 financial crisis was a case in point when securitisation moved risks out of banks to investors.

The next challenge was macroprudential policy. Central banks were supposed to impose measures other than interest rates on the financial system to cool macro risks such as the real estate market. Quantitative easing gave a quasi-fiscal role to central banks by supporting the government debt market and reducing borrowing costs.

The next major challenge was to address climate change concerns and channel finance into environmentally friendly projects. Another task was to address inequalities and bring about an inclusive economy.

The political masters of central banks are increasingly frustrated at their narrow mandates. The criticism ranges from French President Emmanuel Macron requesting more support for growth and environment from the European Central Bank, to President Xi Jinping demanding more support from the People’s Bank of China for domestic growth and the country’s development priorities, such as the digital economy and countering possible economic sanctions by western countries.

CCP is encroaching on China’s central bank

In 1995, the Law of the People’s Republic of China on the People’s Bank of China formed the basis for the modern central bank. It is respected among peer central banks, including those meeting at the Bank for International Settlements and the International Monetary Fund. The law defined the role of the state council and made clear that the central bank does not act as an agent of government.

Earlier this year, sessions of the National People’s Congress and the Chinese People’s Political Consultative Conference proposed a revision to this law. Following the Central Economic Work Conference last December, Xi wants a financial system with Chinese characteristics. The PBoC’s independence is already heavily constrained by the state in comparison with peer central banks in the West, but these proposals mean subjecting the financial system even further to the guidance of the Chinese Communist Party, in line with other government areas.

Xi later proposed a more active monetary policy with open market operations to support growth. China has been cautious in following the QE of western counterparts.

These new proposals would subject the PBoC to greater dominance by the state and, more worryingly, by the CCP. The world’s central banking community should oppose such blatant erosion of central bank independence as well as other mandate creeps.

There are good reasons why the global central banking community should oppose the mission creep. First, though central banks have huge power, their leaders are not accountable to the general population, but rather to their political masters. Second, once you start mission creep – such as increasing the responsibilities of central banks – where does it end? Third, the basic job of central banks is complicated enough. Low interest rates caused asset prices to soar while increased borrowing was the only rational thing to do. By raising interest rates, central banks have targeted inflation but compromised financial stability as banks saw their assets depreciating and debtors saw their debt servicing capacity eroded.

Central banks should return to their basic functions and do them well, or risk being turned into just another department of the government.

Herbert Poenisch is Senior Fellow, Zhejiang University, and former Senior Economist, Bank for International Settlements.

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