At last week’s conference of central bankers in Jackson Hole, Wyoming, the main topic of conversation was off the program.
In the margins of the meeting, many of the bankers talked about the threat to their independence posed by meddling politicians. Nobody presented a paper on the subject, because it’s a tough one for the professionals to air in public.
I understand the reticence. Whether or how to impose democratic accountability on central banking has become the most important question in political economy, not just in the U.S. but also in Europe and around the world. Unfortunately, the answer that’s emerging is unfit for public consumption. We can have proper checks and balances or good central banking, it seems, but not both.
The idea that central banking could be kept above politics was never really plausible, but for a long time central bankers could get away with pretending otherwise.
An independent central bank can promise to keep inflation low more credibly than a bank directed by a finance ministry -- i.e., by politicians tempted to pump up the economy for short-run electoral purposes. The credibility of the promise shifts expectations in the economy, which makes the promise easier to keep. That’s the case for independence. Crucially, you could also argue (as long as you didn’t stop to think about it) that merely keeping inflation low could be done without straying into contested political terrain.
That was always a dubious proposition. Even a narrow-purpose central bank -- one with a simple anti-inflation mandate -- must decide how hard to lean against a boom and how urgently to fight a recession. In other words, it has to weigh control of inflation against stability in jobs and the real economy, and that question is unavoidably political.
This trade-off was a matter of great controversy during the early 1980s when Paul Volcker, the Fed chairman, drew praise and blame for inflicting a recession on the U.S. economy to get inflation down. For the next 25 years, the question was mostly set aside. That changed when the recession forced central banks to innovate. Suddenly, the issue of independence is the elephant in the room.
First, the traditional tools of monetary policy stopped working. Once the Federal Reserve, the Bank of England, the European Central Bank and others had cut short-term interest rates to zero, they had to deliver further monetary stimulus in unorthodox ways -- for instance, by expanding their balance sheets through quantitative easing. This takes risk onto the public sector’s books and, depending on what kind of assets the banks buy, channels support to particular economic sectors. It’s at least as much a fiscal as a monetary operation.
Second, as John Cochrane of the University of Chicago pointed out recently, the Fed (like many other central banks) has been given new regulatory powers. Regulation is not a value-free process that can be left to disinterested technocrats -- least of all if it’s used to advance goals such as more lending to small businesses or easier refinancing for distressed mortgage borrowers. Wider regulatory powers are another move deeper into political territory.
Cochrane highlights the problem but doesn’t say what should be done about it. Because he’s leery of central-bank activism, he leaves readers thinking that the Fed needs to be reined back. I disagree. I’m for central-bank activism. I think we would be in much worse trouble if the Fed hadn’t grown out of its usual role and acted as it has, and I wish that it and the ECB would act even more boldly. I can’t pretend, though, that this would be constitutionally kosher.
Something no central banker with an eye to keeping his job can say, but which is nonetheless true, is that the U.S. and Europe are suffering a systemic failure of democratic government. Central banks are encroaching on the politicians’ terrain out of necessity. They are doing what elected politicians should be doing, because the politicians refuse to.
Under today’s conditions, with short-term interest rates at zero, countercyclical fiscal policy has to be granted a bigger role than usual. (There’s a strong, though admittedly not universal, consensus among economists in support of this view.) This role has two equally important dimensions, as Fed chief Ben S. Bernanke keeps saying, albeit in prudently elliptical terms. Budgetary stimulus should be maintained or increased in the short term, and public debt should be contained and reduced (under the terms of a plan announced right now) in the medium term.
The Fed, Bernanke never tires of observing, can’t do it all. The point is, at the moment he has no choice but to try. Washington’s political paralysis makes intelligent use of fiscal policy impossible, so monetary policy must do everything.
Fiscal policy is paralyzed in Europe, too, though for different reasons. The sticking point there is not an ideological quarrel about the proper role of government, but a fight between the European Union’s stronger, better-run economies on one side and its weaker, badly run economies on the other, about who helps whom and to what degree. Really, it’s a fight about what “Europe” means. The upshot is the same: fiscal paralysis and bitterly contested demands for the central bank to fill the vacuum.
Conservatives in the U.S. are very different from conservatives in Europe (who themselves differ a lot from country to country), but they have this much in common: They want the Fed and ECB to stay out of politics and concentrate on keeping prices stable. In a better world, where the elected branches of government did their jobs, that would be excellent advice. The world we have is one of acute political dysfunction, so it’s a formula for catastrophe. Already the pressure has slowed the banks’ response to the current emergency, and if the critics prevail they’ll make things even worse.
You can have textbook checks and balances, with all political actors held accountable to voters and independent agencies held to a narrow technical mandate. Or you can have an economy on the path to recovery. Reluctantly, I’ll take the latter.
(Clive Crook is a Bloomberg View columnist. The opinions expressed are his own.)
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