Here and there around the world, governments are urging central banks to ease the pain of belt-tightening – and ward off the risk of an economic relapse – by taking their time to shrink balance sheets that have billowed during the financial crisis.
The risk for markets is clear: if supine central banks are unwilling to stand up to domineering politicians, investors will take fright at the threat of inflation and bid up interest rates, short-circuiting the very recovery that governments crave.
Yet it’s fair to ask in the light of experience whether the conventional wisdom is right that independence is the be-all and end-all for a central bank.
After all, the lax monetary policies long followed by the independent Federal Reserve were a root cause of the US credit bubble, critics contend.
In China, by contrast, major monetary policy decisions are made not by the People’s Bank of China but by the State Council, or cabinet, yet China has largely managed to enjoy low inflation alongside breakneck economic growth.
“I don’t believe in absolute independence at central banks,” said Mario Blejer, a former head of the Argentine central bank.
Blejer said he would put more emphasis on the technical capabilities and political savvy of a central bank rather than its degree of autonomy from the government.
“I don’t think independence for a central bank means that it can have an overall economic policy which is different from the line of the government,” Blejer told reporters in Frankfurt.
The issue is far from academic in the case of Argentina, where President Cristina Fernandez recently sacked her central bank chief for refusing to hand over more than $6bn of foreign exchange reserves to repay government debt.
So what if a government ordered its central bank to raise its inflation target to four percent from two percent, as the IMF’s chief economist, Olivier Blanchard, suggested in a provocative recent paper?
“I think the central bank would have to tolerate that,” said Blejer, currently a member of the monetary policy committee of the Bank of Mauritius. “It cannot be that a central bank would say ‘we’re not in favour of your policy’ and would continue to do whatever they want.”
Stephen Roach, chairman of Morgan Stanley Asia, says there comes a point when central banks have to take steps that might offend politicians: they must be the ultimate police of economies and financial markets.
Roach’s worry is that they have fallen down on the job.
“There are no independent central banks left in the world today despite what they like to say in the West. And I think that is a real tragedy,” Roach said in Beijing recently.
“Politicians don’t have the political will to stop inflation or asset bubbles,” he said. “And nowhere was the failure greater than in my own country, the United States, where the Federal Reserve has been repeatedly compromised by political pressures.”
Necessary but sufficient?
The Fed is in good company. Barely a day goes by without Japan’s finance minister or other senior politicians berating the Bank of Japan for its failure to quell deflation.
Haruhiko Kuroda, a former vice-finance minister who now heads the Asian Development Bank, is among the critics.
“In Japan, even now prices are still declining so price stability is not yet realised. So the central bank in Japan should do more to regain price stability,” he said in an interview during a recent visit to Beijing.
Does that mean the BOJ should do the government’s bidding? A 1997 law granted the central bank greater autonomy, but two government representatives on its monetary policy committee can still request that a vote be postponed. And there is a presumption that government and central bank will be on the same policy page.
Choosing his words carefully, Kuroda said independence is a good thing, but the BOJ cannot be “aloof” from the responsibility a central bank has to keep the price level steady.
“In maintaining price stability, the independence of the central bank is, if not sufficient, probably a necessary condition,” he mused.
Investors certainly prefer the shield of independence.
In Asia, government interference has been less invasive than in Argentina, but New Delhi was leaning for a time on the Reserve Bank of India not to tighten too quickly, before it became clear that inflation was heading for double digits. The central bank raised interest rates by a quarter-point last Friday.
And in Seoul, the government has invoked its right for the past three months to send a vice-finance minister to attend central bank meetings for the first time since 1999. Coincidence or not, the Bank of Korea has kept interest rates unchanged.
Manu Bhaskaran with Centennial Asia Advisors in Singapore described the Bank of Korea as a highly credible central bank and said it would be a pity if that reputation was weakened.