Can you have an independent Central Bank in a democracy?

Yesterday, we saw how the Bank of England has been far from independent over the last 11 years, as it has been slimmed down and bossed around by the present government. The main blame for the current high level of inflation rests with the government. The Bank’s failure to control price increases as advertised is understandable when you see how the government changed targets, arranged appointments and took powers away from the Bank.

Today we should ask: Can you have an independent Central Bank in a democracy? The answer, of course, is only if certain, very specific requirements are met. There are three necessities to create and preserve a so-called independent Central Bank:

1. All the political parties capable of forming or influencing government must support an Independent Central Bank, whatever it does, whenever it does it.
2. Government must refuse to interfere or override when the Central Bank gets it wrong, even though there will be strong pressure for it “do something”.
3. There must be no other policy aim or requirement that comes to take precedence over the desire to keep the Central Bank independent.

The nearest any democratic country got to a truly independent Central Bank was post-1945 Germany. The folk memories of the hyper-inflation of the inter-war years were so strong, that the political parties all agreed that they would rest control of inflation in an independent Central Bank and live with its rulings. It had just one main task – to defend the internal and external value of the currency – the newly created DM. The Central Bank made a fairly good job of the task, which made it easier for the political parties – and the public – to go on supporting it. In the end, however, two political priorities emerged, which meant the end of the experiment. The first was German unification. The German government was so determined to see it through quickly and favourably to East Germany, it overrode very good advice from the Central Bank. It created far too many DM to replace the Ost mark in East Germany, which blew the Central Bank’s controls out of the water, and added to the economic turbulence created by re-unification. Subsequently, the politicians decided European integration was such a high priority that they would destroy the currency the German Bank was set up to defend. The death of the DM went through with scarcely a murmur from the Central Bank, which showed it accepted the supremacy of the German government.

Some say the US has a truly independent Central Bank. Certainly, if you want a so-called independent Central Bank, the US model is probably the best to follow and has proved to be relatively long lasting. National banking was established by the National Currency Act in 1863 to help finance the civil war. The banking system was subject to frequent crises, which led to a wide-ranging enquiry and public debate in the opening decade of the 20th century. In 1913, after endless rows over the relative roles of centralised and de-centralised banking, and over private banks and public involvement, a compromise was reached with the creation of the Federal Reserve Board and its system of banks.

The genius lay in the flexibility and the careful compromises in its constitution. The executive – the President of the US – appoints the Board members, but the Senate has a role in ratifying their appointments. The Fed has to work within the government’s economic policy, and has wide-ranging requirements that relate to employment and growth, as well as to inflation. It works closely with the Treasury over government debt-management and the wider economic aims. The whole system is subject to Congressional oversight. If the political support for this sophisticated and balanced system ever did break down, Congress could legislate to change it. It has survived and flourished because the Fed has been responsive to the public mood, to the needs of each Administration, and to changing fashions in the worlds of banking and economics. The Fed system brings in all the important players and balances their views and interests. Its handling of the Credit Crunch has showed this flexibility, responding with the Administration to the change in priority, from inflation fighting to recession fighting.

The UK should study other regimes, and learn more about the need for commonsense and balance in the system. The UK’s version of an independent Central Bank left a much enfeebled institution, shorn of important powers and duties, unable to deal with a government that decided to borrow far too much for comfort, and decided to change the one central target at a damaging time.


  1. Matthew
    May 18, 2008

    That was an interesting piece. What about the SNB? Too small?

    By the way are you now in favour of the central bank setting interest rates (what we are calling 'independence') or do you still believe it should be done by the Chancellor?

    Reply: It is party policy to make the Bank more independentn and to let it set rates.

  2. Kit
    May 18, 2008

    Let's no forget it was the Fed that caused the Great Depression and the current sub-prime mess.

  3. Freeborn John
    May 18, 2008

    Parliament may choose to delegate its powers for numerous reasons, for example to reduce decision-making costs or to enhance the credibility of long-term policy making. In the former case there is a danger of bureaucratic drift where the delegated authority uses its own discretion to achieve policy outcomes that those who originally delegated the power do not approve off. This danger increases when the ‘chain of delegation’ becomes very long (as it is with the powers conferred to the EU for example). In general I think parliament should not delegate its power in these cases because the risk of bureaucratic drift is so high compared to the dubious gains. In the case of a central banker the rationale for delegation is quite different; the goal is to deliberately delegate power to an authority (a conservative central banker) known to value one policy outcome (lower long-term inflation) more highly than the delegating authority and therefore to enhance the credibility of a policy known to be in the public interest.

    So to answer your main question, I would say that having an independent central bank automatically implies a ‘democratic deficit’ but never-the-less is to the long-term advantage of the public. Central banking is not a unique case either. Judges for example exercise one of the three classical forms of political power but are unelected in (almost) all countries. The skills required to be a good judge are very different from those required to run for elected office, involving long experience of case law gained over many decades and the benefits of delegating judicial power to independent judges is widely held to be in the public interest. Our independent central bank is very new compared to our independent judiciary, and has yet to establish the legitimacy that comes from being imagined to be the best possible system. However I would like to see an incoming Conservative government improve rather than abolish this new institution because experience shows that we will most benefit from an independent central bank under future left-wing governments which historically have attached a low priority to low rates of inflation.

    Reply: It is Conservative policy to make the Bank more independent.

  4. Adrian Peirson
    May 18, 2008

    Our Baning system is a Fraud, the Fed and the Bank of England are PRIVATE Companies, Depressions are deliberately created to vaccuum the Nations wealth into the vaults of the Global Elite.

    Don't take my word for it.

    The Global Elite Own you and your children.

    Reply: Nonsense. By the way the Bank of England is 100% owned by the Tresury on behalf of taxpayers.

  5. James Barlow
    May 18, 2008

    Any thoughts on Milton Friedman's contention that the Federal Reserve's actions served to worsen the Great Depression? (Per A Monetary History of the United States, 1867-1960)

    Reply:Yes, they did

  6. Martin
    May 18, 2008

    John..good post…It is a bit unfair of Gordon to seemingly blame the BoE for rising inflation..BoE has no control whatsoever on high energy costs, travel costs,fuel costs,council tax etc. etc. He has only the interest rate to manipulate…which many would argue is a 'blunt instrument'. Your view would be appreciated.

    Reply: It was more Gordon than the Bank

  7. Adrian Peirson
    May 18, 2008

    Any thoughts on Milton Friedman’s contention that the Federal Reserve’s actions served to worsen the Great Depression?

    It appears it may have, the Fed is a Private Company and the IRS ( tax office ) is Constitutionally illegal.

    Reply: He is probably correct, and studied the US experience much more than I have. I do not know how you sustaimn the argument that the IRS is illegal.

    1. Adrian Peirson
      December 18, 2008

      The IRS is illegal because the Federal Reserve is a Private Corporation. It is NOT a Federal institution.

      It is put there to give us the illusion of freedom, democracy yet the leadership of all three parties are chosen in secret Bilderberg meetings.

      Since currency is unbacked by anything of value, why does Govt Print Gilts instead of the Money it wishes to Borrow.

      If Govt had Printed EXACTLY the same amount of money rather than Borrowed it (through the issuance of Gilts) over the past decades,

      would our children have £1Trillion pounds worth of debt.

      We are being Farmed, Gutted, Mugged.

  8. Matthew
    May 18, 2008

    Thanks Mr Redwood. But I'm still interested in your change of heartr – in the late 1990s you argued forecfully that the Chancellor should set interest rates, not the Bank of England, and because he didn't they were higher than they otherwise would be. When, and for what reason, did you change your mind?

    Reply: Please read my reply more carefully.

  9. mikestallard
    May 18, 2008

    Thoughtful and thought provoking blog which I enjoyed a lot, although I do not know anything at all about banking.
    Are there not three in a bed at the moment though? The Treasury, the BofE and the FSA? That, to a layman, seems quite ridiculous because doesn't the bank have to move very fast? I thought the Northern Rock fiasco was caused by a slow moving, cumbersome apparat which lagged behind events often by up to a crucial month as its different bits disagreed with each other. .

    That doesn't seem to me to be contentious.

    I am, however, worried about this: isn't the FSA foisted on us by Europe? Doesn't the Euro come, in most European countries, above the pound? I am concerned, actually, that our rivals and, yes, people who wish us to fail, are in charge of one third of our financial situation.

    It would be nice to get a smidgeon of reassurance here.

    Reply: they are not yet in charge of our currency but have increasing influence over our economic policy thanks to this government's failure to stand up for our interests and independence.

  10. Adrian Peirson
    May 18, 2008

    Thans for the reply John

    The bank of england Building may well be Owned by the Treasury but my understanding of the Situation is that Public money is Borrowed into existance from a Private source to the tune of £20 Billion worth of Interest Per year.
    I now there are other ways of raising Public Money but one example is the Issuance of Gilts.
    Instead of Issuing Gilts Why can the Crown not simply mint its own Money Free of charge and Issue that into circulation ( thus saving us the Interest paid on Gilts )

    Reply: If you do too much of that it is inflationary.

  11. Adrian Peirson
    May 18, 2008

    The IRS is illegal because Constitutionally only the American Govt has the ability to Issue Money and it should be backed by real assets like Gold.

    In 1913 the Federal reserve was set up, The Words Federal & Reserve intended to deceive the American Public in that it was not Federal but a Private Company.

    Neither does it any longer have any reserves.

  12. Freeborn John
    May 19, 2008

    If one assumes that an independent Central Bank is desirable to build a low-inflation bias into economic policy-making, the issue arises as to how realise this independence in a country where one person dominates a de-facto single chamber legislature that cannot bind its successors, and where there is no distinction between regular and constitutional law. In short how to prevent a future Prime Minster simply abolishing the Bank’s independence when it pursues policies not to his/her liking, or using this implied threat to render the Bank’s independence nominal?

    It seems to me that it cannot be done except as part of wider constitutional reform in the UK. The ideal perhaps might be a written constitution, whose articles might (among other things) establish an independent central bank with a goal of achieving price stability below a fixed maximum (say 3%) with the government of the day being able to set a lower (but not higher) target. Modification of this constitution would require referendum or at least a super-majority in parliament.

    Alternatively, if the House of Lords were to become elected, then a US-like system might become credible in the UK with the government nominating central bankers, an elected Lords confirming them and the appointee having security of tenure for say 4 years such as to be able to act as a countervailing power to the government during this period. However it seems to me that the current unelected Lords could not play the role and the Commons is no substitute when it is controlled by the same prime minister nominating the bankers.

    Since I see no way that the Bank of England can ever really be independent under the current system, I am wondering what the conservative proposal is to achieve a truly independent central bank that might defy the government of the day? Jack Straw and Gordon Brown have made some interesting sounding proposals in recent years on constitutional reform (not related to central banking), but actual progress seems slow and I am not aware if these proposals are supported by the Conservatives. Do you agree that the Bank of England can never really be independent without constitutional reform?

    Reply: I have set out the conditions needed for an independent Central Bank in a democracy in my piece. The Conservative party is looking at a number of ways of making the MPC more independent, especially by changing the method of appointing the members.

  13. Matthew
    May 19, 2008

    I've read your response (did you mean the one above) and it doesn't really answer my question (if it does can you point out where?).

    For a while after the BoE was given the power to set interest rates, you argued that this was the wrong decision, and that because it was setting interest rates they were higher than they should be, and would be, if the Chancellor had been setting interest rates.

    This both suggests you thought it was 'independent' of government in its rate setting (despite your requirement (1) above not being met by definition) and that you thought that was a bad thing. So my question is when, and for what reason, did you change your mind?

    Reply: I made clear that it was not independent and was a critic of the removal of powers from Day One. I thought it kept rates too low when the governemnt switched targets, and made clear my opposition to that political intervention. The Conservative party does support a more independent Bank of Engl;and, and I set out how that could be achieved in the Economic Policy Report, but my blog piece shows the conditioons needed to create an independent Bank. I have not changed my view – circumstances have changed over what is the appropriate level of interest rates, and how much independence political parties really want.

  14. Pascal
    May 19, 2008

    Funny how you did not mention the ECB.

    They are vilified by politicians on the continent (Sarkozy comes to mind) because it is not allowing them to spend their way to buy elections (which really is the main reason for having independence, the credibility factor), but still manage to have rates lower than here, and a very strong currency.

    The Bundesbank had credibility in spades, which meant lower costs for Germany.

    I believe that it is the model to follow, and if the Germans supported it, it is because they could see that it made them richer in the long term.

    Reply: I do not mention the ECB because it does not live in a democracy – it part of the quangocracy in a quangocracy.

  15. APL
    May 19, 2008

    Freeborn John: "and where there is no distinction between regular and constitutional law."

    Well, since the 2002 Laws judgement in the 'metric martyrs' case, there is now a distinction. Convieniently, the EEC '72 act turns out to be one such.

    Apparently in a constitutional inovation his lordship revoked the long standing doctrine of implied repeal.

  16. Matthew
    May 19, 2008

    Sorry to go on, and I am thankful that you are taking the time to reply, but I'm still not quite clear.

    "I made clear that it was not independent and was a critic of the removal of powers from Day One. I thought it kept rates too low…"

    Maybe, but you also said earlier that the independent Boe was keeping interest rates too high and risking a recession, and it would be better for the Chancellor to be in charge of setting interest rates as they would be lower.

    When did you change your mind on THIS issue (i.e. the Chancellor was best placed to set interest rates), and what was the reason – that the UK economy didn't go into recession or something else?

  17. Neil Craig
    May 19, 2008

    The problem for democracy is not this one specific case but the fact that government takes up so much of the economy (about 45% though it would be twice that if all the regulatory costs were included as real losses to government power). This means that government becomes the only game in town & all interest groups in the country lok to it as the prime source of money.

    If the government took only 30% of GNP & 20% was ring fenced what I would consider legitimate welfare (NHS, Pensions, schools) it would not be a prize for special interests to so fight over.

  18. Freeborn John
    May 20, 2008

    A clarification for APL: There is clearly legislation on the statute books of a constitutional nature in the UK, going back as far as the Bill of Rights and even Magna Carta. When I said there is no distinction between regular law and constitutional law in I meant that the same simple majority in both Houses of Parliament may repeal either, such that law of a constitutional nature cannot truly act as a ‘law to government’ in this country. That we are free at all in this land under such arrangements in purely down to the good grace of the political class.

  19. APL
    May 21, 2008

    FBJ: "That we are free at all in this land under such arrangements in purely down to the good grace of the political class."

    Well, yes. But so what? Take Ireland for instance, the constitutional statute is not above being ammended, just watch the comming Lisbon treaty referendum. Look at the behaviour of the political elite in Ireland in the treaty of Niece the treaty of Amsterdam when ever the Irish had the audacity to vote against the wishes of the political class, they were simply told to go and vote again. So much for constitutional statute!!

    In the USA, where there is a much more clearly defined constitutional document, there is a body of opinion that the federal reserve, now approching 90 years in existance is an unconstitutional institution. The US constitution mandates the coinage of the USA, and has been ignored in this respect since the establishment of the FED. The US Supreme court has been taken over by judges who choose to innovate rather than interpret the law. So even when you have a defined and well established constitutional document, what is observed in the constitution is purely down to the good grace of the political class. So much for constitutional statute!!

    What plagues us (with due respect to our host) *is* the professional political class. It is a mistake pay MPs the whole lot should clear out and get real jobs.

  20. Adrian Peirson
    May 22, 2008

    John I appreciate that simply turning on the Printing presses would deflate the value of money.

    Howevere All things being equal and taking into consideration all inflationary precautions, it must be cheaper for the Govt to Print Money, than to Print Bonds that carry an interest penalty serviced by our taxes, why does it do this.
    Why Not give General Dannat £2Billion freshly printed notes rather than raise this £2Billion through Bonds, because these Bonds must be services via our taxes and they carry an idditional cost in that they must be repaid with interest.

    Who benefits.

    The reason I labour the point is that in the Video Below and in a number of articles it appears that once upon a time the Crown had the legal right to Print money ( that was then backed by Gold ).

    This was subverted by an agreement between the Crown and the International Bankers who agreed that they would print all the money that Govt desired if our taxes could be channelled up to the International Bankers.

    Thinking about it, this would explain why Govt Prints Bonds, Not Currency.
    Bacause if you think about it, who is it that buys these Interest bearing Bonds, I would argue that in large part it is Banking and financial sector.

    So the question remains, All things being equal, why would a Govt Print Gilts rather than Print Money.

  21. Neil Craig
    May 22, 2008

    You can never repay money because it costs more to get it out of circulation than to put it in. If you double the money in circulation then to buy back the new half would take as much gold as would have paid for all the old currency in the first place.

    If you go for bonds you at least know that it is possible to pay them off & the public can at least believe they will be redeemed. If you print money everybody knows it won't be.

  22. Adrian Peirson
    May 24, 2008

    You can never repay money because it costs more to get it out of circulation than to put it in.

    Why do we need to repay it or take it out. Simply print it and distribute it into the economy. It doesnt need repaying.

    If you double the money in circulation then to buy back the new half would take as much gold as would have paid for all the old currency in the first place.

    I refer the honourable gentleman to the answer I have just given.

    If you go for bonds you at least know that it is possible to pay them off & the public can at least believe they will be redeemed.

    If Govt simply prints the money, it doesnt need repaying. simply sat ro General Dannat, Here is £2 Billion, happy shopping.

    If you print money everybody knows it won’t be.

    Again Why repay bonds when givt could (but doesnt) simply print the Money.

    Let me give an example, General Dannat wants £2 Billion for our Army, so Govt prints a load of bonds and sells then.
    Bankers buy them, general dannat now has £2 Billion and goes shopping.

    5 Years later the Bankers come to the Givt with the Bonds and the Givt must Pay 5 Billion PLUS 5% interest Per annum which govt can only raise ny Taxing us to the tune of £5.25Billion

    If Govt simply printed the Money and gave it to general Dannat it would cost NOTHING.

    Paper bonds haver no more intrinsic value than Paper money.

    So who benefits from doing the money dance this way ( You already know the answer to this John )

  23. mikestallard
    May 24, 2008

    All paper money is, surely, just a piece of paper promising to pay the bearer, on demand, a certain amount of gold?
    In default of gold, we have the strength of the economy represented. the promise still holds – as long as the economy stands up to scrutiny.

    When that economy is overvalued, the pieces of paper lose their power.

    The banking system knows this and makes money out of it.
    Therefore, if you print more money, its value is bound to go down because you have more money resting on the same economy.
    Ask Argentina, any Sierra Leonian or President Mugabe.

  24. Neil Craig
    May 24, 2008

    So if nobody ever even hopes the government will "pay on demand" then we have open ended inflation where a loaf of bread costs millions (as in Zimbabwe & 1920s Germany among others), nobody ever tries to save any money (at least in currency form) & all such assets or fixed income pensions become worthless. I don't see the upside of that.

  25. Adrian Peirson
    May 29, 2008

    But our Money is NOT backed by gold it can't be, Gordon sold most of it, at its most basic level he swapped a pile of Gold for a Pile of Paper !!! there is something wrong there, my belief is that this Gold now sits in the vault of a Private International Banker somewhere.
    Our country is being gutted, fishing waters, industries, Gold.

    Funny that Argentina's
    economy collapsed after the Falklands, there are a number of countries that do not have central banks run by the IMF and the Global Bankers, Venezuela, Syria, Iran, and North Korea,

    do these countries sound familiar.

  26. Adrian Peirson
    June 1, 2008

    I can tell You're still not convinced are you John,

    Ok try this

    The Elite's Brueprint for a global business Model.

    Now watch this.

    Now watch this


    See, I told you.

  27. Adrian Peirson
    June 4, 2008

    Are we no longer Sovereign, are we Owned by the International Bankers.

    Our Birth certificate effectively makes us nothing more than Corporate entities.
    We are Owned by the Global Elite who farm us, at the end of our usefull life the Establishment disposesses us of our Wealth ( forcing the elderly to sell their homes to pay for care ) then disposes of us as quickly as possible.

    This is not just a quirky way of looking at our plight it appears that our laws have been set up this way.

    This explains why Corporatism seems to be taking over, closing down the Post offices to be replaced by Fed Ex, Privatising failing hospitals (which the Govt causes to fail)

  28. Jim
    December 13, 2008

    Its quite clear to me a government should have the right to issue its own money.
    The right too issue money into the econmy of a nation by a central bank effectivly trumps the power of any political party.

Comments are closed.