Central bank independence: the orthodoxy's under attack

Have we handed the foxes the keys to the hen house?

Japan's central bank and treasury are discussing co-operating more on economic policy — news which has sent the Nikkei soaring, opening around 2 per cent higher than it closed yesterday, and rising further throughout today.

We've already had previews of this news. After all, new Prime Minister Shinzo Abe was elected on a promise (or threat?) to force the Bank of Japan to do more monetary easing, and has already made other unconventional moves like "nationalising" industrial stock to encourage private-sector investment.

Nonetheless, it was unclear that Abe would actually pull it off. Business Insider describes it as "one of the most taboo concepts in modern economics", noting that "the Treasury is supposed to do fiscal policy. The central bank is supposed to do monetary policy. And that's that".

But, as with so many orthodoxies of economics, the idea of central bank independence has come under attack since the global financial crisis.

Central banks are supposed to be independent to remove the risk that politicians will use monetary policy the same way they all-too-frequently use fiscal policy: to engineer temporary booms, gain brief popularity, and win elections. By removing control of policy from people who stand to gain if they favour the short- over the long-term, monetary policy ought to be "better run".

Monetary policy is worse for this sort of thing because it depends far more on ideas of credibility and restraint than fiscal does. Much of the job of a central bank involves saying the right things, rather than doing them. There's a thousand ways to hold interest rates low, but doing so while explicitly saying they will be low for the next two years (as with the Evans Rule) is very different from doing so while saying they may rise at any time.

But it's important to remember that an "independent" central bank may be no such thing. If principal-agent problems apply to banks run by democratically elected politicians, they apply just as effectively to banks run by technocratic ex-financiers. Frequently, this works well. As Tyler Cowen wrote in 2009:

The default selection mechanism favors bankers, i.e. lenders, people whose interests make them more favorable towards lower inflation.

Given the trend in monetary policy for most of the last thirty years was a desire to reduce then suppress inflation, that convergence of interests was beneficial. But there's no particular reason to expect the convergence of interests between the economy as a whole and one subsection of it to be a long-term thing.

If nothing else, we get the downsides of "independent" central banks when their policy turns to whether to backstop banks and bankers. As a lengthy Atlantic piece by Simon Johnson from May 2009 describes, too many of those decisions were actively favouring the interests of the finance industry when those interests were in direct opposition to the rest of the nation.

And as we've faced an increasing number of unprecedented situations, even the old truth has come under attack. As Joseph Stiglitz said in India earlier this year:

In the crisis, countries with less independent central banks-China, India, and Brazil-did far, far better than countries with more independent central banks, Europe and the United States. There is no such thing as truly independent institutions. All public institutions are accountable, and the only question is to whom.

Obviously the independence, or not, of the central banks is unlikely to have been the deciding factor between whether China or Europe came out of the crisis intact. But more and more people are starting to realise that concepts of independence need to be re-examined, as technocratic rulers are demonstrated to be just as beholden to their own interests as democratic ones, and as those interests continue to diverge from those of the nation as a whole.

So if Japan is about to break a taboo, maybe it has picked the right time to do it.

Pedestrians walk past a stock quotation board in Tokyo on January 11, 2013. Photograph: Getty Images

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

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Benn vs McDonnell: how Brexit has exposed the fight over Labour's party machine

In the wake of Brexit, should Labour MPs listen more closely to voters, or their own party members?

Two Labour MPs on primetime TV. Two prominent politicians ruling themselves out of a Labour leadership contest. But that was as far as the similarity went.

Hilary Benn was speaking hours after he resigned - or was sacked - from the Shadow Cabinet. He described Jeremy Corbyn as a "good and decent man" but not a leader.

Framing his overnight removal as a matter of conscience, Benn told the BBC's Andrew Marr: "I no longer have confidence in him [Corbyn] and I think the right thing to do would be for him to take that decision."

In Benn's view, diehard leftie pin ups do not go down well in the real world, or on the ballot papers of middle England. 

But while Benn may be drawing on a New Labour truism, this in turn rests on the assumption that voters matter more than the party members when it comes to winning elections.

That assumption was contested moments later by Shadow Chancellor John McDonnell.

Dismissive of the personal appeal of Shadow Cabinet ministers - "we can replace them" - McDonnell's message was that Labour under Corbyn had rejuvenated its electoral machine.

Pointing to success in by-elections and the London mayoral election, McDonnell warned would-be rebels: "Who is sovereign in our party? The people who are soverign are the party members. 

"I'm saying respect the party members. And in that way we can hold together and win the next election."

Indeed, nearly a year on from Corbyn's surprise election to the Labour leadership, it is worth remembering he captured nearly 60% of the 400,000 votes cast. Momentum, the grassroots organisation formed in the wake of his success, now has more than 50 branches around the country.

Come the next election, it will be these grassroots members who will knock on doors, hand out leaflets and perhaps even threaten to deselect MPs.

The question for wavering Labour MPs will be whether what they trust more - their own connection with voters, or this potentially unbiddable party machine.