“Jjust kick ’em up the rump a little.” That’s how President Richard Nixon advised Federal Reserve Chairman Arthur Burns to convince the rest of the Fed board to cut interest rates in 1971. One way or another, central bankers followed. Cuts helped Nixon win re-election by boosting employment. They also contributed to double-digit inflation that was not to be tamed significantly until Paul Volcker ran the Fed in the 1980s.
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On December 14, the Federal Reserve hiked interest rates another 0.5 percentage point; the European central bank (ECB) and the Bank of England was to follow shortly thereafter The economist‘s weekly edition published. Technocrats have spent the decades since Burns making more difficult Nixon-like interference. An academic cottage industry dedicated to counting and ranking the independence of central bankers. In 2020, according to the Bank of England census, there were more than 150 central banks classified as independent – about 90 more than in the 1970s. That ECBThe autonomy of is contractually guaranteed. When President Donald Trump criticized Jerome Powell, the current Fed Chair, for raising interest rates in 2018, the President seemed both backward and impotent. This year, President Joe Biden has emphasized his support for the Fed. Some British politicians from the ruling Conservative Party are even arguing that the Bank of England has not raised interest rates enough.
The notion that today’s central bankers could be pressured into abandoning the fight against inflation is therefore harder to sustain. However, it would be a mistake to claim that monetary policy is completely isolated from politics. For there are forces threatening the independence of central bankers in new and insidious ways.
First, central banks are less persistent and more willing to play on the gallery than they were. In the Volcker era, economists speculated that independent central bankers might function best if they were more restrictive than society on inflation. Over time, they rejected “inflation maniacs” in favor of “flexible” inflation controls that also accounted for employment. By 2020, central bankers looked out of work. The Fed said it would not raise rates at all until the job market tightened, an approach that left it hopelessly helpless as inflation picked up. Its top executives had been on a “fed listens” tour, during which the public, not seriously concerned by inflation for decades, told central bankers that boosting employment should be their priority. Proponents of direct central banker accountability forget that politicians’ will to distort monetary policy stems from what voters want.
Central bankers need as much independence from the public as they do from their elected officials. But they are spending more and more time on press conferences and speeches. Right now, Mr. Powell and his colleagues are using their public profile to speak hard truths about how long-term price stability is the foundation of prosperity. But their resolve has yet to be tested by a recession that could trigger a backlash like the one Volcker has had to fend off. Only after such a backlash does it become clear whether central bankers see their job as leading or listening.
The second threat comes from the new tool central bankers have been using since the 2007-09 global financial crisis: quantitative easing, or buying government bonds with newly created money. Over the past decade, central bankers have become a major force in bond markets as they attempt to keep long-term interest rates low. They have also at times resolved financial crises by becoming “market makers of last resort” and buying bonds to restore calm – a task that has become more important due to the rise of financial intermediaries outside of the traditional banking system. Central bank balance sheets have grown much faster during crises than they have shrunk during tightening periods. At today’s pace of quantitative tightening (quart) for example, it would take ten years for the Bank of England’s balance sheet to return to pre-financial crisis levels.
The greater the presence of central bankers in the markets, the more decisions they ultimately make of a political nature. That ECBItaly’s balance sheet has become the channel for a de facto communitarization of some of Italy’s debts. The central bank has not started yet quart, but it has unveiled another bond market “tool” to prop up indebted countries. The Fed has faced allegations that its support of corporate bond markets during the Covid-19 pandemic favored larger companies over smaller ones dependent on bank lending. Much of the rise in Britain’s debt service costs this year has gone through the Bank of England, which has to pay interest on the reserves it spent to carry it out qe. Mission Creep has set a goal for central bankers. Some want central banks to do even more, using their balance sheets for a variety of purposes, including subsidizing the fight against climate change.
take it to the grave
The final threat comes from government spending. Economists’ models say central banks’ ability to control inflation depends on sound public finances, which Eric Leeper of the University of Virginia has called the profession’s “dirty little secret”. When governments borrow freely, they undermine the credibility of monetary policy without even making a call to the technocrats who set interest rates. All it takes to generate self-fulfilling inflationary expectations is the belief that the government will one day inflate away some of its debt. Central bankers should therefore look nervously at the increasing tendency for governments to borrow and spend, for example on huge energy subsidies, as in Europe. They should also fear the severe budgetary pressures projected for the coming decades as the aging population drives up spending on health care and pensions. Politicians today are very different from Nixon. Nevertheless, the independence of monetary policy from politics looks shaky. ■
Read more from Free Exchange, our column on business:
Tackling sexual harassment could bring significant economic benefits (December 8)
A 1980s playbook for dealing with inflation (December 1)
The weather again determines the economic results (November 24)
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