On Thursday night I was asked to deliver a lecture on public policy to a Cambridge University audience. I tackled two main issues, the successes and failures of UK economic policy 10980-2011, and the topic of this blog.
I argued that in a democracy where a Parliament or elected officials are sovereign, you cannot ever have a completely independent Central Bank.
The UK’s experiment with such a Bank began with the Brown reforms of 1997. These took away from the Central Bank the crucial powers and duties of banking regulation and government bond issuance. In return the Bank was granted some stronger powers to settle official interest rates without reference to the Chancellor of the Exchequer. The hollowed out Bank was far from independent. It was another example of how spin so dominates political dialogue, and how wrong it can be. The Chancellor had more power through the Office of Debt Management and the creation of the tripartite system of banking regulation with him at its head,than before the changes.
Even in the one area where it appeared the Bank had greater independence, we discovered this did not apply when events dictated political intervention. The first important intervention came when the Chancellor changed the target, setting 2% on the CPI instead of 2.5% on the RPI. This loosened monetary policy, as the RPI target was tougher. It had the fortunate effect for the government of keeping interest rates lower for longer.
The second override came when in the middle of the Credit Crunch Finance Ministers of major countries made a joint decision to cut rates in concerted action. The Bank of England obliged by convening a special meeting and duly cutting rates, but no-one can seriously believe that was their initiative unconnected to the political decision.
The third came when the government was persuaded that the Bank needed to buy in bonds and print more money. There the Bank itself agreed that the Chancellor had to approve the decision.
Proponents on independent Central banks say the German Central Bank post 1945 is a great example of how well these independent Banks can work. For a long period it is true the German Bank set interest rates without political interference. There was a political consensus in Germany about the economic policy, and for many years it worked well. The politicians had no need to change the Bank or alter the arrangements.
When the moment came that the politicians wanted to amalgamate the Ost mark with the DM, a crucial decision for the conduct of monetary policy, they overrode the advice of the Central Bank. They made the Bank do it earlier than they wished, and at a much higher exchange rate for the Ost mark than the Bank advised. That single decision did damage to German monetary policy. It was the right political decision as the elected officials saw it.
Finally, the politicians decided to abolish the DM. The German Central Bank was independent and had as its main duty the maintenance of the internal and external value of the currency. They had to accept the political imperative to abolish it from under them.
Do you still think the German Central Bank was independent?
On some occasions – as with the concerted interest rate reductions – the politicians had better judgement than the Banks. On others, as with the Ostmark-DM decision, the Bank made a better economic judgement but politics prevailed.
There cannot be an independent central Bnak in a democracy. A Bank may be given a free run for a long period, to do as laid out by the politicians. If it disappoints, or if the requirements changes, the politicians will change the Bank.