Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 3 September 2017

Could independent central banks be advisory?

With fiscal councils (or Independent Fiscal Institutions) now commonplace in advanced economies, a natural question arises. Why are all these councils advisory, while independent central banks have control over monetary policy? For fiscal policy we seem to have delegated advice [1], while for monetary policy we have delegated control. In this post I want to focus on control over how policy instruments are changed, and not control of the goals of policy. For clarity assume that governments still control the ultimate goals of monetary policy (e.g. an inflation target) and fiscal policy (e.g. a target for the deficit in 5 years time).

As fiscal councils are the less familiar, it is natural to try and answer this question by asking why fiscal councils are not given control over fiscal policy. I am, of course, not talking about controlling the detail of government spending or taxes, but instead setting a target for the projected deficit which governments should aim to achieve in a budget. There are lots of potential answers to that question, which I have written about elsewhere.

However we could ask the question the other way around, and I cannot remember anyone asking it this way. Why are there no independent advisory central banks? In the UK, for example, imagine having the MPC meeting, and then immediately advising (in secret for a short time) the Chancellor of their recommendation for interest rates. The Chancellor would very quickly (within an hour or day?) decide whether to accept that recommendation or do something different. After that, the decision and the MPC’s recommendation would be announced.

Two straightforward points. First, a system of that kind could only work in the US if Congress gave the President the power to accept the Fed’s recommendation or impose the President’s own decision: perhaps not something we would want to contemplate right now. In the Eurozone the ECB would have to give recommendations to Ecofin, which might make it both impractical and perhaps undesirable. Second, this form of delegation is obviously weaker than giving complete control to the central bank, and that in itself may be a reason why it is not adopted.

Nevertheless, for a country like the UK, it would be a mistake to underestimate the political pressure the Chancellor would be under to accept the central bank’s public advice. The Chancellor or Treasury minister would be entirely responsible from deviating from the recommendation given to them, and if it went wrong they would incur a considerable political cost. In these circumstances, it would be understandable for governments to reason that there was little to be gained from having the power to overrule central bank advice. They would get it in the neck if they overruled this advice and turned out to be wrong, but equally if the MPC make mistakes they would also have ultimate responsibility for accepting this advice. If in practice nearly all of the time they are going to accept the central bank’s recommendations, why not give them complete control so that at least you are not implicated when things go wrong.

If this reasoning is correct, it raises a difficult question for those who argue against central bank independence but still accept monetary policy’s primary role in stabilising the economy outwith the ZLB. Of course many governments used to be happy to control monetary policy, as long as the advice they were getting was secret. But if that advice is public, as surely we all agree it should be, would even formally advisory central banks start to in effect control monetary policy because governments would never incur the risk of going against their advice? In which case, why so much fuss about independent central banks that do control monetary policy being undemocratic? I stress again that I’m talking about control of month to month interest rate changes, and not the goals of monetary policy (inflation targets or NGDP targets). I think those should be democratically decided (as in the UK, but not the US or EZ), and that central banks should be accountable in a meaningful way if they do not achieve these goals. But for the day to day business of setting rates, I cannot see that much would be gained by putting those under democratic control. 

[1] In the absence of delegating advice to an independent institution, advice would come from the the internal civil service. 

5 comments:

  1. This is the usual skilfully "euphemistic" discussion, because the crucial aspect of "independence" is not who has "control" over interest rates, but to ensure that the inflation target is announced publicly in advance.
    The purpose of that is to ensure that government policy cannot suddenly and secretly switch to target higher inflation to "confiscate" a chunk of the real value of debt; that is to reassure "the markets" that the costs of government policy will always be borne by workers and not by property owners, as in G Osborne's (and D Cameron's) very clear policy statement:

    A credible fiscal plan allows you to have a looser monetary policy than would otherwise be the case. My approach is to be fiscally conservative but monetarily active.

    Consider this alternative: instead of imagining the inflation target being publicly announced and the interest rate target being advisory (and public after the decision “within an hour or day”), imagine the inflation target being secret (and it would have to be launch-codes level secret, as it would be hugely market-moving) and the central bank fully "independent" and "in control" free to set any interest rate for its lending to banks, without ever mentioning or hinting at the inflation target.

    The latter would be a much, much bigger change than the former.

    In practice also "independence" as such is an illusion for most central banks, because of course they tend to be rather politically sensitive, when it matters, "independence" real meaning being "on the side of the wealth creators". For example certain central banks have been hugely "accommodative" of war spending and finance bailout spending, regardless, or perhaps of the impact on inflation, just taking care via regulatory means to ensure that the resulting inflationary impact was directed at asset prices, which as we know are not "inflation" because only wages are "inflationary", as a FOMC member said:

    What the Fed did, and I was part of that group, we frontloaded a tremendous market rally starting in march of 2009. [ ... ] Once again, we frontloaded, at the federal reserve, an enormous rally in order to accomplish a wealth effect.

    The only central bank that arguably was truly independent, pursuing stable and low inflation no matter the cost to "wealth creators" or anybody else, has been the Bundesbank. And even that reflected some long-term political realities.

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  2. Can fiscal policy be technocratically organised along the lines of monetary policy?
    I think no, because monetary policy is not really independent, either in terms of targets or month to month rate setting. Some blame for failed policy may attached to the MPC and Governor, but politically the buck always stops with the Govt. That's why at at section 19 of part 2 of the BoE Act 1998 it sets outs the governments reserve powers subject to parliamentary approval within one month AFTER direction is given. We are highly unlikely ever to see this happen because the the Governor would have already jumped before he was pushed, and the holder of new orthodoxy would be installed. It only looks independent, because its politically convenient for neoliberal politicians, not because its technocratically a better way to run the shop.

    http://www.bankofengland.co.uk/about/Documents/legislation/1998act.pdf

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  3. There’s no sharp dividing line between a CB which is as independent as CBs can be and in contrast CBs which are non-independent (aka “only advisory”). As to whether the position of CBs in the above scale has any effect on inflation, Bill Mitchell claims not. Scroll down to chart here:

    http://bilbo.economicoutlook.net/blog/?p=9922

    I quite agree with Simon’s last sentence: “But for the day to day business of setting rates, I cannot see that much would be gained by putting those under democratic control.”

    Positive Money and co-authors advocate that sort of system here:
    http://b.3cdn.net/nefoundation/3a4f0c195967cb202b_p2m6beqpy.pdf
    To be more exact, PM & Co advocate merging monetary and fiscal policy: i.e. the state just prints money and spends it (and/or cuts taxes) when stimulus is needed. As to HOW MUCH stimulus there is, that’s decided by a committee of economists, perhaps the existing BoE MPC in the case of the UK. In contrast, HOW that money is spent (education versus health versus defence etc), that’s obviously a political decision, and that stays with politicians under PM & Co’s system.

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  4. Does your mention of NGDP targets mean you have moved on your opposition to them?

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  5. To me this is a difference between deciding the final port of call for the ship and the route to get there. I believe it is the politicians who should decide the final port of call but the CB who should decide the route.

    Based on this it is the CB that has the expertise and also, crucially, disinterest in avoiding what may be unpopular decisions at times. It seems to me that the advisory route gives you nothing and would be seen for what it is: control by the government.

    You don't have to argue this on the basis of non interference

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