One of the enduring myths that mainstream macroeconomists and the politicians that rely on their lies to depoliticise their own unpopular actions continue to propagate is that of ‘central bank independence’. This is the claim that macroeconomic policy making improved in the ‘neoliberal’ era following the emergence of Monetarism because monetary policy was firmly in the hands of technocratic bankers who were not part of the political cycle. As such, they could make decisions based on fundamentals rather than the requirements of the political cycle. The corollary was that vote-greedy politicians, who operate on short-term political cycles, would be willing to compromise the ‘longer-term’ health of the economy to splurge on populist programs that might increase their chances of re-election. As a result of the mismatch between the political cycle and the, longer, economic cycle, the neoliberal solution was to make monetary policy independent of the political cycle. Except, of course, it didn’t and cannot. The latest scaremongering about the ‘loss’ of central bank independence was published in the UK Guardian last week (February 28, 2020) – From the Fed to Bank of England, central banks must up their game. The author is a former deputy governor of the Bank of England Board and former director general of the CBI. The interesting point about the article was not the further elaboration of the myth, but, rather, his assessment that the chances of reforming the European Union treaties in any direction “are vanishingly small”. Read: zero. From the mouth of the elites. I hope our Europhile Left colleagues absorbed that bit, at least.
I have written about central bank independence before:
1. ECB continues to play a political role making a mockery of its ‘independence’ (June 12, 2018).
2. Censorship, the central bank independence ruse and Groupthink (February 19, 2018).
3. The sham of ECB independence (October 24, 2017).
4. Trump might do us a favour – expose the myth of central bank independence (November 14, 2016).
5. The sham of central bank independence (December 23, 2014).
6. US Federal Reserve chairman loses his independence (April 28, 2011).
7. Central bank independence – another faux agenda (May 26, 2010).
The tenet of the UK Guardian article is straightforward.
The presumption is that central banks are ‘independent’ from the elected politicians who determine fiscal policy (government spending and taxation) and that recent trends – such as the rise of ‘populist’ leaders (when is the elected leader ever not populist?) such as Donald Trump – are threatening to compromise this ‘hallowed’ state.
The presumption is wrong and so all the rest of the analysis that follows from it is thus reflective of the dominant depoliticisation ideology that is one of the central characteristics of neoliberalism.
The deployment of depoliticisation has allowed elected governments to divert responsibility to ‘external’ agencies or ‘independent’ central banks for the harsh policy regimes that have undermine our material standards of living and retrenched public services.
The British Labour Party certainly were early practitioners when Dennis Healey lied in the mid-1970s about having to borrow money from the IMF because the British government had run out of funds.
He really wanted to impose austerity and not destroy the Social Contract with the Trade Unions but had to work out a way to shift the blame. Who better than to use the IMF as the ‘external’ agency forcing Britain to do something bad.
It wasn’t me it was them!
The same holds for the central bank independence myth.
Elected governments wanting to pursue the redistributional characteristics of fiscal austerity (shifting income to the top end of the distribution) have been able to claim that monetary policy is the only ‘effective’ macroeconomic policy tool in normal times and that interest rate changes are the sole responsibility of the various monetary policy committees.
And if interest rate rises are unpopular, then you know who to blame.
It wasn’t me it was them!
Except, the ‘them’ are not accountable to the people via any normal democratic process.
And this all ties in then, to the rising democratic deficit in our nations during this period of neoliberal blight.
So, Howard Davies (the UK Guardian author) is keen to maintain the claims that any step back from ‘independence’ is like having “a fox in charge of the chicken coop”.
In other words, bad!
He also implicates politicians he doesn’t like via their alleged attempts compromise the ‘independence’ – Trump, Recep Tayyip Erdoğan, Narenda Modi, etc.
But promotes characters he likes – such as Mario Draghi as people who “issue a firm defence of the concept” – that is, of independence.
Except at that point, his grasp on history rather tenuous.
The ECB was a major part of the Troika. I will come back to that.
Why do I say that central bank independence is a myth?
First, clearly, as the UK Guardian article points out, elected politicians appoint the management boards of central banks including the governors.
That makes the flavour of the monetary policy boards reflective of the politics of the day.
As one former Reserve Bank of Australia governor noted in a speech in 1994 (Source):
Given that central banks are created by government legislation and derive their powers from such legislation, they cannot be completely separate from the government.
Second, in many jurisdictions, the Finance or Treasury ministers can overturn a monetary policy decision should they wish. There are various means through which this power can work.
The aforementioned Speech also noted that:
In Australia, the legislation provides that in the event of a dispute over monetary policy, the government can override the Reserve Bank by tabling its objections before both houses of parliament.
Third, and most importantly, on a practical or operational level, the central bank and the treasury functions have to be closely coordinated on a daily basis to ensure that the policy targets of each are capable of being met.
That alone compromises any suggestion that the central banks can operate separately from the political sphere, which determines fiscal policy parameters.
In my blog posts – The consolidated government – treasury and central bank (August 20, 2010) and Understanding central bank operations (April 27, 2010) – I laid out the core Modern Monetary Theory (MMT) argument that there is nothing to be gained from having central banks as separate institutions (note this is not the same thing as ‘independence’) from the treasury function.
The discussions trace the impacts of fiscal policy on the monetary aggregates that the central banks watch as part of their monetary policy operations.
In isolation, a national government fiscal deficit, which results from the government spending more (via crediting bank accounts and/or posting cheques) than it drains via taxation revenue from the non-government sector, results in an overall injection of net financial assets to the monetary system.
This boosts the so-called monetary base, which is made up of:
- The currency (notes and coins) held by the public and issued by the government);
- The deposits that the commercial banks have with the central bank – the so-called reserves;
- The liabilities the central bank has to the non-bank financial intermediaries.
Conversely a fiscal surplus, which results from the government spending less than it drains via taxation revenue from the non-government sector, results in an overall withdrawal of net financial assets from the monetary system.
This reduces the monetary base.
In the former case, in isolation, the deficits add reserves to the cash system which are in excess of the levels desired by the banks for their clearing purposes and so they try to rid them via interbank market competition.
Unchecked, this process would drive down the short-term interest rates to zero and compromise a positive central bank interest rate target.
However, that is not what actually happens in reality – in most cases.
It is clear that the central bank sets the short-term interest rate according to its current policy aims and its expectations of likely movements in variables that influence its monetary policy formation.
In general, central banks:
1. Prevent reserve excesses through the use of open market operations (selling interest-bearing government debt to the banks in return for reserves – which drains the reserves back to their ‘desired’ levels).
2. Offer a competitive support rate on excess reserves to the banks which stems any urge to dispense them.
The two options are equivalent in terms of their impact and just result in different accounting.
In the second case, the support rate effectively becomes the interest-rate floor for the economy.
Central banks then manage the corridor or spread within which the short-term interest rates can fluctuate with liquidity variability.
They do that on a daily basis.
And, that essential liquidity management function has to be performed in close liaison with the treasury departments – so that the bank can understand what fiscal injections/withdrawals are coming up on any given day and the implications for the banking reserve system.
Does political interference constitute an abandonment of central bank independence?
The previously cited Speech from a former RBA governor noted that central bank “independence”:
… does not preclude Ministers from commenting on monetary policies, and it does not preclude central banks from consulting with the government on monetary and other policies.
This is a curious position to take.
If, politicians publicly denounce the current policy stance – think Trump’s recent statements – then monetary policy is being politicised.
But, more importantly, you will note that the former Governor failed to mention the opposite situation – where central bank boards comment on fiscal policy and/or actively become agents in the implementation of fiscal policy.
At that point, the sham of central bank independence is clearly exposed.
We have countless historical examples.
The ECB is clearly not legally constructed to enforce European Commission dictates with respect to the Member States about fiscal policy, labour market policy, product market policy or anything else like that.
It would be strictly illegal for it to become involved in those things.
Yet on August 5, 2011, Jean-Claude Trichet, the then President of the ECB, sent a letter to the Spanish Prime Minister José Luis Rodriguez Zapatero
demanding that the Spanish government push fiscal austerity harder, further deregulate labour markets and introduce measures to cut wages.
The letter is available from the – ECB – after it was reclassified for public release on December 19, 2014.
It demonstrates how involved the ECB was in pushing the Troika line, which is not the impression it gave back at the time and also demonstrates that the neo-liberal concept of independent central banks is another one of those myths that allow policy makers to deflect responsibility for poor decisions that damage the prospects of people.
We could also consider the ECB’s role in June 2015, at the height of the Greek stand-off with the European Commission. The ECB breached its legal obligation to maintain financial stability by threatening the Greek government with damage to the Greek banking system in the event that the government failed to tow the line on austerity.
It was clearly acting as a political agent.
More recently, in a different way, as the consequences of this era of monetary policy dominance is becoming more obvious – zero to negative interest rates, massive build up of central bank balance sheets due to holdings of government debt – it is clear the there is no major push back coming from central bankers, the financial markets and citizens for fiscal policy to become the dominance policy tool.
I have reported in the past how central bankers are now increasingly calling for the neoliberal bias against fiscal policy to be reversed.
Former Bank of England governor, Mark Carney told the Financial Times in January this year (Source) that:
… central banks were running out of the ammunition needed to combat a downturn … Mr Carney echoed other central bankers, such as the European Central Bank’s Mario Draghi and his successor, Christine Lagarde, in recommending that governments consider fiscal policy tools, such as tax cuts or public spending increases when tackling a downturn.
The current RBA governor has repeatedly demanded that that Treasurer abandon the Australian government’s obsession with pursuing a fiscal surplus.
These are all examples of central banks being significantly involved in the political process and compromises any hint that they are ‘independent’ of that process.
The most important contribution of the UK Guardian article
As noted in the Introduction, most of Howard Davies’ article was forgettable.
However, at one point he comments on the appointment of Madame Lagarde to the helm of the ECB saying:
In the eurozone, a similarly neutral choice emerged as Draghi’s successor and a change in the ECB’s status would require a new EU treaty. The chances of that are vanishingly small. EU leaders show no indication of taking the risk of opening up the constitution to further referendums, as would be necessary in some countries.
How is that for a statement from an ‘insider’ about the way the EU works.
He admits that the EU elites would not dare open up the Treaty to a vote by the people, because they know, as they did before the third stage of the Maastricht process was ratified, that the people would not support their neoliberal contrivance.
So, better to stick to the script that the Treaty is sacrosanct and that there is no prospect of reform.
Game, set and match.
This is exactly the end that Jacques Delors and his gang sought when they drafted the current Treaty and what the European Commission sought when they bulldozed the Treaty of Lisbon through after sensing the ‘democratic’ voice (in Denmark and France, for example) would not support their ambitions.
Yet, I see on Twitter and in other media, a relentless event schedule held by Europhile progressives where the latest ‘reform’ proposal is aired and lots of self-congratulatory Tweets espouse a new future for Europe.
Meanwhile back at the ranch – the reform prospects are “vanishingly small”.
Not a lot for a progressive person to look forward to in these sorts of discussions.
But we should be ever vigilant because some ‘socialist’ or Labour Party type here or in Britain or elsewhere will propose yet another ‘fiscal rule’ that elevates so-called ‘independent’ central banks to the top of the decision making hierarchy and grant the banks veto power over the elected treasury or finance minister.
That is exactly what the failed British Labour Party ‘Fiscal Credibility Rule’ actually intended. I hope the advisors who came up with that nonsense never get their foot in the policy making door in that nation again.
That is enough for today!
(c) Copyright 2020 William Mitchell. All Rights Reserved.