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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Emily Thornberry heckled by Labour MPs as tensions over Trident erupt

Shadow defence secretary's performance at PLP meeting described as "risible" and "cringeworthy". 

"There's no point trying to shout me down" shadow defence secretary Emily Thornberry declared midway through tonight's Parliamentary Labour Party meeting. Even by recent standards, the 70-minute gathering was remarkably fractious (with PLP chair John Cryer at one point threatening to halt it). Addressing MPs and peers for the first time since replacing Maria Eagle, Thornberry's performance did nothing to reassure Trident supporters. 

The Islington South MP, who voted against renewal in 2007, said that the defence review would be "wide-ranging" and did not take a position on the nuclear question (though she emphasised it was right to "question" renewal). She vowed to listen to colleagues as well as taking "expert advice" and promised to soon visit the Barrow construction site. But MPs' anger was remorseless. Former shadow defence minister Kevan Jones was one of the first to emerge from Committee Room 14. "Waffly and incoherent, cringeworthy" was his verdict. Another Labour MP told me: "Risible. Appalling. She compared Trident to patrolling the skies with spitfires ... It was embarrassing." A party source said afterwards that Thornberry's "spitfire" remark was merely an observation on changing technology. 

"She was talking originally in that whole section about drones. She'd been talking to some people about drones and it was apparent that it was absolutely possible, with improving technology, that large submarines could easily be tracked, detected and attacked by drones. She said it is a question of keeping your eye on new technology ... We don't have the spitfires of the 21st century but we do have some quite old planes, Tornadoes, but they've been updated with modern technology and modern weaponry." 

Former first sea lord and security minister Alan West complained, however, that she had failed to understand how nuclear submarines worked. "Physics, basic physics!" he cried as he left. Asked how the meeting went, Neil Kinnock, who as leader reversed Labour's unilateralist position in 1989, simply let out a belly laugh. Thornberry herself stoically insisted that it went "alright". But a shadow minister told me: "Emily just evidently hadn't put in the work required to be able to credibly address the PLP - totally humiliated. Not by the noise of the hecklers but by the silence of any defenders, no one speaking up for her." 

Labour has long awaited the Europe split currently unfolding among the Tories. But its divide on Trident is far worse. The majority of its MPs are opposed to unilateral disarmament and just seven of the shadow cabinet's 31 members share Jeremy Corbyn's position. While Labour MPs will be given a free vote when the Commons votes on Trident renewal later this year (a fait accompli), the real battle is to determine the party's manifesto stance. 

Thornberry will tomorrow address the shadow cabinet and, for the first time this year, Corbyn will attend the next PLP meeting on 22 February. Both will have to contend with a divide which appears unbridgeable. 

George Eaton is political editor of the New Statesman.