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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The SNP retains power as Scottish Labour faces being beaten into third

Ruth Davidson’s Conservative Party looks on track to become the official opposition in Holyrood.

As expected, the SNP have performed well in the Scottish elections, with an increased vote share and some key gains – particularly from Labour in Glasgow, where Nicola Sturgeon’s party took all eight constituency seats. As it stands, they could be on course for a second successive majority in Holyrood, once the list members are fully counted.

The story of the night, though, is the demise of Scottish Labour, which put in its worst ever performance in Scotland (my stalwart liveblogging colleague Stephen Bush points out that it’s the party’s worst result since universal suffrage was introduced in 1928). The party’s vote share was done across Scotland, and the results are sufficiently poor that they could see them fall behind the Conservatives to become the third biggest party north of the border.

Losses for Labour include seat of Eastwood in Glasgow, where Scottish Conservatives deputy leader Jackson Carlaw defeated Ken Macintosh. Labour had held the seat for 17 years, though it had been Conservative beforehand.

Other key losses for Scottish Labour include Dumfriesshire, where they were beaten into third; Renfrewshire South (which went to the SNP); Cowdenbeath, where Gordon Brown's old constituency manager and protégé Alex Rowley also lost to the SNP; Glasgow Pollok, where former Scottish Labour leader Johann Lamont lost to the SNP’s Humza Yousaf. There was a close call for Labour’s Jackie Baillie in Dumbarton, where she held on by just 109 votes.

Rare successes came in Edinburgh Southern, where Daniel Johnson took the seat from the SNP’s Jim Eadie (although since the seat is effectively a four-way marginal, it’s not a particularly indicative gain), and East Lothian, where former Scottish Labour leader Iain Gray managed to increase a previously slender majority.

Speaking to the BBC, Scottish Labour leader Kezia Dugdale said:

“A very bad night for the Labour party… There’s no doubt that the constitution has dominated this election.”

She also confirmed that “no matter what, 100 per cent, I will remain leader of the Scottish Labour party”.

In a great night for her party, Ruth Davison won her seat in Edinburgh Central, making her the first Scottish Conservative leader not to need the list system to enter the Scottish Parliament  since 2005. The Tories also gained Aberdeen West from the SNP as well as their success in Dumfriesshire.

The Liberal Democrats also had a better-than-expected night. Their leader, Willie Rennie, took the Fife North East seat from the SNP, and his party also had comfortable holds in Orkney and Shetland.

Caroline Crampton is web editor of the New Statesman.