Debate is raging over the ideal degree of separation between governments and central banks.
The battle over central bank independence is shaping up. While the consensus over the past decades has been that more independence is always for the better and that central banks should stick purely to pursing sound money and low inflation, the impact of the financial crisis has led to a divergence of opinions.
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In one corner, Mark Carney, the next governor of the Bank of England (BoE) and outgoing head of Canada’s central bank, is willing to switch from inflation targets to nominal gross domestic product targets to help the economy. In the opposite corner, Jens Weidmann, president of Germany’s Bundesbank, is alarmed by blatant government interference in the activities of central banks in Japan and Hungary.
Both arguments have their merits but are those who argue too strongly for independence mistaking the real role of central banks? Can they ever really stand alone in policy terms as economic tumult hits? Is a central bank that refuses to purchase government bonds to restore confidence really serving the national interest?
Mark Carney, view from IMF 2012
Historically, the world’s leading central banks were often created to finance wars and pay off government debts. In modern times, their role has changed and they have wanted to part from their “dark roots”, as professor Olivier Jeanne from Johns Hopkins University puts it. But the level of independence they were granted has many different shades, as economist Christopher Crowe and academic Ellen E Meade found in their research on central banks for the International Monetary Fund in 2008. They also found that increases in central bank independence have tended to occur in countries with high levels of past inflation.
As the challenges the world faces evolve in time – wars are replaced with sovereign debt crises and other economic catastrophes, at least in the developed world – so too should the goals and remits of the institutions that try and control economic events. This could mean central banks becoming less independent.
The big danger, however, is that politicians start to expect too much from central banks. They cannot by themselves produce economic growth, full employment, a competitive exchange rate and low inflation. Sir Mervyn King, the current governor of the BoE, recently called for the UK government to do more to support the disappointingly slow recovery. Central banks are powerful, but they are not almighty. Governments should bear this in mind.
