On Thursday I gave a lecture to a Cambridge University audience on the conduct of public policy. I chose to speak about UK economic policy over the last thirty years. Today I will share the summary of what I said about independence in Central banks, and tomorrow my conclusions on what has been good and bad in UK economic policy since 1981.
I do not see how you can have a truly independent Central Bank in a democracy. The elected officials and Parliament have the last say. They are accountable for the economic results, and they will override the Bank when they think it is necssary or when the public complains about the Bank’s conduct.
The UK is said to have an independent Central Bank following the Brown reforms of 1997. It is strange this piece of spin has stuck, given how far from reality it is. Mr Brown took away the power of the Bank to raise the government’s money, putting that task into the Treasury under Ministerial control through the Office of Budget Management. He stripped the Bank of its powers to regulate the commercial banks, giving those to the FSA. He said he strengthened the Bank’s independence over monetary policy.
However, he subsequently altered the aims of the Bank when he switched the requirement from keeping the RPI to 2.5% a year increases, to asking for 2% increases in the CPI. This represented a loosening of monetary policy, inviting the Bank to keep rates lower for longer at a crucial time in the build up of the credit boom. CPI usually goes up by 1% less than RPI.
At the peak of the Credit collapse Finance Ministers including the UK Chancellor met and agreed concerted interest rate reductions. They were right to do so. The Bank quickly convened a special unscheduled meeting and cut rates by the agreed amount. It is difficult to say this was anything other than political leadership on rates. When it came to decisions to increase bond buying and money printing all agreed that the senior elected official, the Chancellor had to authorise it. Some independence!
Some commentators say the German Central Bank is truly independent. It is the case that for many years after 1945 the Bank was allowed to supervise rates and money policy without material interference from politicians. This was because there was a political consensus about what the Bank was doing,and it was relatively successful.
When the politicians wished to amalgamate the DM with the Ostmark in East Germany, the Bank advised delay. They were overriden. The Bank advised a lower rate for the Ostmark. The politicians insisted on one DM to one Ostmark and forced it through. The Bank gave good economic advice. The politicans required they act on a political imperative.
Finally, the politicians decided to abolish the DM altogether. As the whole point of the Central Bank was to defend the external and internal value of the DM, who can say it was independent when it had its currency taken away from it?
There is no such thing as an independent Central Bank in a democracy. The elected polticians can always change its remit, its personnel, or even the currency it manages.