Politicians circle independent central banks
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There are few things on which economists are in total agreement. But practitioners of the dismal science come pretty close to it on the issue of independent central banking.
Most see the move to hand operational control over monetary policy to central banking technocrats as having provided vital underpinning for the recent long period of low inflation and stable growth.
Yet the independence of the world’s leading central banks is increasingly under threat.
One manifestation of the politicians’ urge to reassert some control came in Japan when the opposition Democratic Party recently vetoed candidates for the governorship of the central bank, leaving the post vacant for several weeks.
Another has been the extraordinary public tussle between the UK Treasury and Mervyn King, Governor of the Bank of England, over the succession to Rachel Lomax, an outgoing deputy governor.
Mr King’s candidate for the post, Charles Bean, the Bank’s chief economist, has prevailed, although Treasury officials had wanted Paul Tucker, the Bank’s head of markets, since they felt the Bank was underpowered on financial stability. Alistair Darling, the chancellor, is nonetheless proposing to impose a committee of financial stability experts on the Bank. Is this the thin end of a long wedge?
Mr King now finds himself criticised in the press for being insufficiently accountable and politically insensitive in his public statements. Whatever one’s view of the arguments, the appearance of friction between the Treasury and the Bank is not helpful to the credibility of UK monetary policy.
As yet, the US Federal Reserve’s position looks less vulnerable. But Paul McCulley of Pimco, the bond fund manager, believes that the game has changed since the Bear Stearns rescue. This, he argues, was a fiscal policy action little different from the role of Congress in bailing out Chrysler.
Having watched the Fed conduct a multi-billion bailout of an investment bank that it did not supervise, the politicians may now apply pressure for the central bank to firefight elsewhere.
That is not to say the Fed’s operational independence in setting interest rates will be impaired. Mr McCulley’s point is rather that the Fed will be less independent in regulatory matters, as well as the size and composition of its balance sheet.
The biggest threat to independence, though, could simply come from a failure to keep the lid on inflation. There are signs on both sides of the Atlantic that monetary policymakers have been slow to recognise the extent of the current inflationary threat.
The relative lack of wage pressure in the developed world has created a false sense of security and a belief that this is no more than a temporary spot of bother with relative prices. Yet the impact of US monetary policy is global and the Fed has been instrumental in loosening monetary policy in all those countries that peg their exchange rates to the dollar.
The current inflationary upturn is not a 1970s-style supply shock, but a demand shock that increasingly reflects overheating in emerging markets such as China. That is where the wage inflation is happening. And excess demand in developing countries is having an adverse inflationary outcome in the developed world that may last longer than expected.
This poses a huge challenge to the credibility of monetary policy. Public expectations of inflation in the UK and the eurozone are already well above formal inflation targets.
In the US there is public scepticism about the story the inflation indices tell. Credibility will not be helped where central bankers are obliged to own up regularly to missing their targets, as the Bank of England’s Mr King expects to do, according to his latest letter to the chancellor.
Independent central banking is not perfect. But it is much, much better than the alternative. A huge amount is at stake here. The likes of Nicolas Sarkozy and Silvio Berlusconi will not hesitate to seize any opportunity to reassert control.
Unfortunately it will take more than central bankerly jawboning, much in evidence of late, to re-anchor our expectations of inflation and pre-empt the political threat.
John Plender is an FT columnist and chairman of Quintain plc
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