Concerns are rising that central-bank independence is at risk, already curtailed by governments eager to control all other levers of growth. The Japanese government’s none-too-subtle strong-arming of the Bank of Japan is one of the most blatant examples (e.g. King 2013).
But the current debate on the risks to central-bank independence misses the point.
Central-bank independence has already been compromised by the financial crisis and by recession. The issue is not independence de jure (there has been little change there); the issue is independence de facto. Central banks do not act in a vacuum. The financial crisis has caused ‘mission creep’, forcing a number of advanced country central banks to venture into uncharted territory: they have massively expanded their balance sheets, accepted collateral of longer maturity and increasingly dubious quality, backstopped government bonds, and tried to direct liquidity into specific markets. The Fed has underwritten both the mortgage market and the government-bonds market; the ECB has stepped in to both protect and discipline high-debt countries; and the Bank of England has a launched a ‘funding for lending’ scheme to boost credit.
Victims of their own success
Yet, even as they have done a lot more than ever before, central banks have acted consistently with their mandate – that is, to avoid an economic collapse that would have sent both employment and inflation well below target. Their contribution has been invaluable, and in a way central banks are now victims of their own success: monetary policy is increasingly seen as the easy solution to all problems. And if monetary easing alone can boost GDP growth back to higher levels, why should governments take tough measures now if they can simply wait for the return of better times?
Central bankers are well aware that monetary policy alone is not enough. Monetary policy cushions real adjustment and helps spread it over time, but the real adjustment does need to happen. The ECB has been explicit about this, making purchases of government bonds subject to policy conditionality. The Fed has been softer but has never stopped reminding us that fiscal and structural policies need to do their part.
No room to manoeuvre
The problem is not that central banks are losing their independence, it is that their room for manoeuvre is being eroded by lack of progress on structural reforms and fiscal adjustment. After trying every trick in the book – and then writing some new chapters – the Fed still faces unemployment at nearly 8%. At the January Federal Open Market Committee meeting, Fed officials put on a brave face, noting that the fourth-quarter GDP contraction was due to temporary factors and that the underlying economy continues to gradually improve. This is all true, but for all that improvement they could only restate their commitment to keeping a long term ultra-loose monetary policy stance. The longer this goes on, the greater the risks of economic and financial imbalances and the harder it will eventually be to unwind extraordinary stimulus, the raising of interest rates and stepping out of mortgage and government bond markets (Taylor 2013). But unless fiscal policy helps, the Fed’s options are limited.
A game of chess
Central banks and governments are constantly sparring in a policy chess game – analysed by a long-standing game-theoretic literature. It’s a game where both players employ threats, signals and commitments. It is also a game where one or both players can turn out to be less than fully rational, at least in the strict economic sense.
Central bankers are subject to pressures from governments. But even if they were not, even if central banks where run by benevolent dictators who could refuse to pick up the phone when the government calls, they would still have to factor the government’s policies in to their own decisions.
It is hard to point to a move by one of the major central banks over the last few years as determined by government interference. Central banks' decisions have been driven first by a desperate desire to avert catastrophe. Th