With central bank independence seeming to be under threat, Nick Maroutsos, Co-Head of Global Bonds at Janus Henderson Investors, explains that the distinction between central banks and politics is not clear cut.
Independence – a short history
Are politicians invading central banks’ territory? The truth is that most central banks have not been independent for very long. In some cases, such as the European Central Bank (ECB), this is because they only came into existence with the currency they support; in other cases, governments took control of the private banks that had been banker to the government.
North America has some of the longest claims to independence, with the Bank of Canada enjoying independence since 1935, while in the US the Accord of 1951 reaffirmed the independence of the US Federal Reserve (Fed) to formulate monetary policy after it had been leant on to support low national debt rates during the world wars. In fact, it was the success of Fed independence (particularly under Fed chairman Paul Volker in the 1980s who was credited with bringing inflation in the US under control) that encouraged several other countries to grant independence to their central banks – the Bank of England became independent in May 1997 and the Bank of Japan (BoJ) shortly after, although since 2013 the BoJ has been co-ordinating policy with the government.
As central bankers have employed more unconventional tools to support monetary policy, it becomes increasingly difficult to distinguish between whether what they are doing is monetary or fiscal. In creating money (expanding the balance sheet) to purchase government bonds, on the premise that this will hold down government bond yields and financing costs, one could argue that this is tacit support for government spending.
It becomes even more curious when the interest that the central bank receives from the bonds it buys with the created money, together with any capital surplus, is then passed across as profit to the Treasury. In the case of the US Federal Reserve this amounted to US$65.4 billion in 2018. Most compliance departments would struggle to reconcile this as the act of independent parties.
Federal Reserve remittances to the US Treasury (US$ billion)
Source: US Federal Reserve, press release, 29 January 2019.
Hector and protector
So what are we to make of politicians seeking to interfere with central banks? In the US, President Trump wastes no moment (or tweet) in letting the US Federal Reserve know what it should be doing, while simultaneously supporting its independence. We may never know whether the Fed’s backpedalling on rate hikes this year was based solely on economic data or whether the barrage of criticism from the White House had any bearing. In India, Urjit Patel, the governor of the Reserve Bank of India until December 2018, resigned following tension between the central bank and the government, which continued to put pressure on the central bank to lower rates and allow ailing banks to extend more credit.
In the UK the opposite tendency holds sway, with Mark Carney, the governor of the Bank of England, accused of hoisting a ‘Remain’ flag over the Bank in reference to his speeches that appear to paint a distinctly negative view of leaving the European Union.
Meanwhile, President Erdogan of Turkey has an unorthodox view of monetary policy, claiming high interest rates cause inflation, and regularly criticising the central bank for keeping rates high. He would appear to follow the Neo-Fisherian school of economics, which argues that the real interest rate for an economy is the nominal interest rate minus the inflation rate, so if nominal rates fall, over the long run the inflation rate must move lower to a level consistent with the long-run equilibrium real rate, and vice versa. President Erdogan recently put his son-in-law in charge of the finance ministry. Such nepotism might seem far-fetched until you reflect that President Trump actively considered his daughter Ivanka for the post of World Bank president.
Yet, it would be unwise to view central banks in isolation. They do not operate in a vacuum but in a heavily politicised world. Central banks function with reflexivity – the feedback loop that sees investor perceptions and the economic environment as key inputs into central bank decision-making. When Mario Draghi, president of the ECB, rode to the rescue of the euro in 2012 with his “whatever it takes” speech, few were begrudging the fact that his actions were as supportive for the European Union’s political project as they were for the currency.
With Draghi’s tenure coming to an end in October this year, manoeuvring is already taking place among Europe’s capitals for who should follow him. Whoever is chosen is likely to offer clues about the direction of political and economic thinking within the eurozone. Potential candidates include Benoit Coeure, a French economist and board member of the ECB, who is widely seen as offering continuity with Draghi’s supportive monetary policy, whereas Jens Weidmann, Germany’s central bank governor, has been a vocal critic of some of the ECB’s accommodative policies. As with most central banks, it is political heads who decide the appointment, underscoring what German novelist Thomas Mann stated: everything is politics.