Is central bank independence the next casualty of the age of populism? In the US, President Donald Trump has declared that the Federal Reserve is “going loco”.
He blames Fed Chairman Jerome Powell for threatening “his” recovery and for market volatility caused in part by uncertainty over the trade war Trump himself started.
In India, reports emerged that the government might invoke a never-before-used section of the law governing the Reserve Bank of India to force it to reverse course on some recent controversial policies. The government wants the central bank to loosen lending restrictions — to fuel economic activity and jobs growth — and turn over more of its cash reserves, presumably to fund populist spending ahead of next year’s elections.
There’s speculation that RBI Governor Urjit Patel might quit if the government doesn’t back off.
Meanwhile, in Europe, the populists who have seized power in Italy spent the past week attacking European Central Bank President Mario Draghi, a fellow Italian, after he warned that Italy’s borrowing costs would escalate unless it kept to Eurozone fiscal restrictions. Luigi di Maio, the head of the populist Five Star Movement and Italy’s deputy prime minister, complained that Draghi was “poisoning the atmosphere”.
Over the past year, three of the ECB’s 19 representatives from national central banks have been dragged into local legal disputes; others have faced pressure to resign.
Central bank autonomy may seem like an immutable fact, accepted globally and for all time. In reality, the consensus supporting it reflects one of the signature achievements of the Age of Technocratic Moderation from the early 1990s onwards.
In 1993, a landmark paper by Larry Summers and Alberto Alesina showed that independent central banks did better at controlling inflation; over the next two decades, independence and inflation targets became the norm or at least a shared aspiration across the globe.
Why do the chilly equations of time inconsistency and macroeconomic theory suggest that central bank autonomy is such a good idea? Precisely because monetary policy is then set by bloodless, independent technocrats.
They don’t have to deal with elections or electorates, and so have a longer time horizon and simpler incentives. No considerations or targets other than inflation should matter to the independent central banker, even if those other factors seem more important to voters or politicians at a particular moment.
It would be impossible, politically, to make that argument for technocratic control from first principles today, in a world that has turned against unaccountable experts. Indeed, the essence of the age of hot-blooded populism is to deny the validity of any and all such arrangements.
Power cannot be diffused to various technocratic experts; it must stay with the “people” or, more precisely, with whichever strongman has declared himself the embodiment of popular sovereignty.
A president who believes that inflation can be fixed by lower interest rates and that any official he doesn’t control is a traitor isn’t going to let his country’s central bank raise rates to the degree economic factors may require.
A prime minister who needs money for his populist spending is going to want the central bank to hand over its reserves. A president who thinks that a galloping stock market is key to his case for reelection is going to demand that rates stay low.
The flood of recent spats underscores the fundamental danger of populism. It’s not just that populists pursue bad policies, which hurt those that they claim to protect.
Central bankers make mistakes, too. The real danger is that the institutions that have been painstakingly established to minimise or learn from those mistakes could cease to exist, or will be fundamentally altered.
Good sense may yet prevail. Trump himself has acknowledged the importance of central bank independence.
In its response to fears Patel might quit, the Indian finance ministry also emphasised the importance of independence (while grumbling that it isn’t the done thing to leak disagreements between fiscal and monetary authorities).
In the quarter-century since Alesina and Summers wrote their seminal paper, the relationship between central bank independence and inflation has been less obvious in the data; Summers himself walked back his claim a bit recently.
While there are sound macroeconomic reasons for this, part of the explanation surely is that central banks are no longer as varied in their institutional strength as they once were.
As with so many other aspects of the apparent triumph of centrist liberalism, though, we would be foolish to assume that this change is permanent and central bankers’ independence will remain sacrosanct.
If the populists do succeed in breaching this last bastion of the technocracy, we may all have to suffer through the instability that follows before we realise, once again, why letting politicians fool around with monetary policy is a bad idea.