Central bank independence used to mean that central bankers would take economic decisions without regard to the political consequences; now it appears to mean that central bankers take political decisions without regards to the economic consequences. This is a very bad development for macroeconomic policymaking because it is likely to give political momentum to those who oppose the prevailing policy framework. The result will be a crisis of legitimacy for the central banking community and an increase in volatility and uncertainty in the world economy writ large.
Consider three illustrations. First, the Swiss central bank released its peg against the euro in order to stave off the inflow of foreign capital. This move was certainly ‘independent’, but it looks more political than economic. To see why, just ask yourself whether the technical advantages for monetary policymakers are more obvious than the distribution of costs and benefits both inside and outside the country. Swiss exporters are clearly suffering and so will the tourist industry. Anyone who took out a mortgage in Swiss francs but earns income in other currencies — like euros, zloty, koruna, etc. — will clearly suffer as well. Swiss central bankers may claim they have good technical motives for floating the currency, but any such sharp division between winners and losers looks an awful lot like politics.
Another example is Denmark. There the central bank is struggling not to follow Switzerland in breaking the peg between its national currency and the euro. Danish central bankers are having to experiment with ever new measures to dissuade foreign investors from bringing their money into the country as a consequence. Indeed, they have even had to enlist the support of the Danish Treasury. Here you might think the technical advantages are more obvious than in the Swiss case. But so are the winners and losers. Not only do Danish firms benefit from a reduction in exchange rate uncertainty, but they also get to borrow at unprecedentedly low costs. Meanwhile Danish savers — including pension funds and insurance companies — are taking losses. Again, this looks like politics, and the hard peg on the euro looks like a political project. Perhaps it is time for Danish politicians to ask the voters if they want to join the single European currency. But of course they already did that in September 2000. The answer was not ‘yes’. The hard peg on the euro is the policy alternative.
The third example comes from the European Central Bank. Last Wednesday the Governing Council announced that assets underwritten by the Greek government would no longer be accepted as collateral for routine liquidity operations. This decision takes effect from 11 February, when the current refinancing period ends and the Greek banks will need to replenish their cash. The decision was well telegraphed in advance. ECB board members have stated repeatedly that the waiver making it possible for banks to use Greek government-backed assets as collateral depended upon the Greek government’s ability to stay in a structural adjustment program set out by Greece’s creditors and supervised by the Troika of the International Monetary Fund (IMF), the European Commission (EC) and the ECB. Greece’s program comes up for review at the end of February and so most market participants expected that the waiver would come to an end. What they did not expect was the timing of the announcement. The ECB explained its decision to move up the date by pointing out that the new Greek government announced its intention to leave the program. That works formalistically, but it is still hard to see how moving up the decision gives the ECB any technical advantages in pursuing its monetary policy objectives. By contrast, it is easy to see how the surprise timing of the announcement could roil the markets and imposes costs on the new Greek government. This is politics, not economics.
The distinction is important. Before explaining why, I should be clear that I am a big supporter of the euro as a single currency, I am a huge admirer of the ECB and its president, and I have an unusual fascination with the exchange rate policies of small advanced industrial economies like Switzerland and Denmark. So this is not the usual anti-euro, anti-ECB, anti-rich small country rant. My worry is that such obvious political interference by central bankers is unsustainable in terms of popular legitimacy. Not only will it chip away at any support for ‘central bank independence’ as a concept but it will also embolden (and empower) those groups who seek to reintroduce politics into monetary policy making. Moreover, these things will happen no matter how much central bankers protest their political innocence and churn out technical or rule-based arguments to justify their actions.
In the world of politics, perceptions matter more than sophistication. Indeed, any attempt to ‘justify’ the influence of central banks in assigning winners and losers is only going to backfire by playing into the rhetoric of populists. Europe’s central bankers have turned the logic of political independence on its head and now they are openly engaged in what looks to most observers like politics. If we somehow get out of this crisis without suffering another major setback, people may be willing to overlook this perceived transgression. If there is another sharp reversal, however, the public is unlikely to be forgiving. Central bankers will become political targets and so will central bank independence. The results will not be good for future macroeconomic policymaking.Follow @Erik_Jones_SAIS