There is no perfect answer. In practice, in any democracy, independent arrangements only last for as long as they have broad politcal and public support. If the independent bodies do the wrong things or if the public loses confidence, then the elected authorities will change them.
I do not favour relying on the chance that the electoral and political party system may just happen to put in the right senior office someone who understands the intricacies of monetary policy and is capable of making good judgements. The senior elected official can at any time override or make the important calls. Mr Darling, after all, seemed to take a very leading role in cutting interest rates and loosening policy at the height of the banking crisis, when there was concerted action by the leading Finance Ministries of the world. It would be better to find a system where good official advice and delegated powers can usually be operated without detailed reference to the senior elected official.
In system with fiat currencies and single Central Banks it makes sense to delegate substantial power to the Governor and senior executives of such a Bank. Under the older UK system the Governor held regular talks with PM and with Chancellor. Differences could be ironed out in private, and a common view reached between the Bank and the government over correct interest rate and monetary policies in the light of the government’s tax and spending policies. Under the newer system the Bank has more authority to settle interest rates on its own, and to conduct more of the dialogue with government in public, by publishing forecasts and warnings about economic developments in the light of the government’s published decisions on tax and spend. The newer system does not, however, preclude private discussion about the intersection of fiscal and monetary policy.
What the public wants is for Bank and Treasury to follow policies which promote low inflation and good rates of growth. Within reason they do not much mind how that is done. The record shows that no political party has avoided some boom/bust cycles. The record also shows that the two worst boom/bust cycles of recent years came about under regimes based on so called independent action designed to avoid political interference in key decisions.
The truth is that an independent Central Bank is only a good idea if it is led by people with great judgement about the cycle. In 1989 we needed Central bankers to withdraw their enthusiasm for the ERM on the obvious grounds that the pound was going up and trying to keep it down would damage monetary and anti inflation policy. We needed a Bank which in 2005-6 made sensible adjustments to avoid excessive credit expansion, and a Bank who from the middle of 2007 made enough money available to markets and cut interest rates fast enough to avoid a run on banks. The fact that we did not get this shows that finding good Central Bank leadership is not easy, and the task itself is not easy for those charged with it.
In many other walks of life democratic government is based on the theory that the generalist, the Minister answerable to the public, takes decisions based on best professional advice, but has the last word in cases of disagreement or difficulty. It is, after all, the politican who has to defend the decisions to the public, and who keeps or loses his job based on the success or failure of the decisions.
Some element of this needs to be included again in our approach to the newly strengthened Bank of England which will emerge from the latest reforms. I welcome the return of bank regulatory powers to the Bank of England. They need to understand bank balance sheets day by day and be able to control them to control the money supply. They should also act in the markets to raise money for the government. Armed with these substantial powers, they need from time to time to confirm they have the support of the government. This could be done through a formal and public process, or through an informal one as used to happen. The senior elected official has to keep his confidence in the Governor, and satisfy himself that Governors in future are more likely to read cycles well than has happened in recent years.
In the end it comes down to people. The Chancellor has to carry the can and make any final or difficult decison. He is best equipped to do this if he has chosen a good Central Bank Governor with judgement and knowledge of the markets. He can then trust him and interfere little if at all. If he has a Governor who is not good at judging he has to find ways of bringing better advice to bear on the problem, or he needs to change the Governor.