BREAKINGVIEWS-Central bank ability matters more than autonomy

By Jon Sindreu

LONDON, Jan 14 (Reuters Breakingviews) - Watching President Donald Trump’s attempts to impose his will on the Federal Reserve, it’s easy to evoke parallels with Zimbabwe or Turkey. In the African country, central bank money-printing led to hyperinflation, while Turkish President Tayyip Erdogan has unconventional theories about why cutting interest rates reduced pressure on prices. But the loss of ill-defined central bank “independence” is a far lesser concern than the undermining of expertise and hollowing out of government agencies, which could neuter their ability to respond to future crises.

On Tuesday, 11 central bankers supported Fed Chair Jerome Powell against the threat of a criminal indictment from the Trump administration, which he says is a pretext to enforce lower interest rates. The consensus among economists goes like this: governments that demand a say over monetary policy always loosen it too much. In the 1970s this tendency caused runaway inflation and forced lawmakers to give central banks the autonomy to credibly stick to an inflation target. Since this arrangement led to a long era of price stability, reversing it could undermine economic stability and cause a market meltdown.

But this is as much folk tale as history. Far from being reluctant to outsource the responsibility to set interest rates, governments often led the charge. Politicians also retained control of central banks' goals. For many, including the Bank of England, the executive branch even sets the specific inflation target, and in most cases it appoints ratesetters. Even when central banks were subordinate to finance ministries they still regularly asserted their autonomy. A current example is the Reserve Bank of India, which has built up credibility with investors even though it can technically be overruled by the government. The Fed's independence, though technically secured in 1951, has also waxed and waned. During the 1970s, Chair Arthur Burns bent to the dictates of President Richard Nixon.

The Bank of Japan, which had its autonomy legally enhanced in 1998 only to be roped into Prime Minister Shinzo Abe's broader reflation push in 2012, underscores the difference between "de jure" and "de facto" independence. This, economist Thomas Cargill has argued, has led to studies grossly exaggerating the role of arm's-length monetary policy in vanquishing inflation. Overly loose policy can wreak havoc in emerging markets with volatile exchange rates, such as Turkey. But the experience of rich nations since the 2008 global financial crisis suggests that coordination between monetary and fiscal authorities may help avert slumps. Meanwhile, putting monetary policy beyond the reach of elected representatives could be stoking public backlash.

A paper published last year by ECB researcher Livio Stracca, which examined 37 advanced countries since 1986, found that central bank independence had no impact on economic performance. Crucially, indicators of the “rule of law” did. This emphasises the real reason to be concerned by Trump's attacks on the Fed: his weaponisation of the Justice Department to intimidate political rivals and concentrate more power under a unitary executive. His dismissal of Federal Trade Commission official Rebecca Slaughter, validated by the U.S. Supreme Court against a 1935 precedent, is part of this broader reshaping of the federal government, which is based on hollowing out expert-led agencies subject to legislative oversight. Here, research is clear: nations that disperse power and retain bureaucratic expertise do better than those that fill every post with politicised appointees.

The U.S. Supreme Court has so far protected the Fed from its decisions on executive appointments, reassuring investors. But autocratic rulers can still resort to packing central banks with loyal yes-people, resulting in a damaging loss of institutional ability. Arguably, the era of monetary authorities targeting inflation in the 1990s and 2000s led to an overreliance on academic economists, who ignored the buildup of financial risks and were ill-prepared to deploy the complex emergency facilities they needed after 2008. When the next crisis comes, the Fed's ability will matter more than its formal autonomy.

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CONTEXT NEWS

On January 13, the heads of 11 central banks around the world issued a ‌joint statement in support of Jerome Powell after the Trump ‌administration threatened the Federal Reserve chair with a ​criminal indictment. The U.S. administration's criminal probe is ‍formally about the renovation of the Fed's headquarters but on January 12 Powell called it a pretext to intimidate the central bank into lowering interest rates.