In defence of Bank independence

The Tories seem to be undermining the Bank of England’s independence. First, Theresa May says there “have been some bad side effects” of low interest rates: “people with assets have got richer…people with savings have found themselves poorer. A change has got to come.” Then Lord Hague says that low rates are “penalising the poor and the prudent" and “losing credibility and producing very dangerous side effects.” And then when Mark Carney queries this, David Davies tweets:

Mr Carney you are an unelected bank official. Theresa May has got every right to tell you how to do your job!

I’m unhappy with these developments. For one thing, as they stand they are plain wrong in three ways:

 - Since 2014, inflation has been below its target. This means that if the Bank has erred, it has been by having too tight a policy. Interest rates have been too high, not too low. Savers haven’t been penalized enough.

 - If Ms May wants the Bank to raise real interest rates, she has the means to do so. She could reduce the inflation target, and remove the Bank’s ability to “look through” short-term price increases.

 - Any successful stimulatory monetary policy will cause people with assets to get richer. This is simply because it will raise expected future GDP and hence raise share prices.

But my disquiet goes further than this.

One problem I have is that none of these statements address the logic for central bank independence. This is that, because central banks have no incentive to stoke up pre-election booms, people will trust them to deliver low inflation. This reduces inflation expectations, which helps reduce inflation at no cost in terms of output. The empirical record is consistent with this theory: see, for example, this paper (pdf) by Athanasios Anastasiou and the many papers he cites.

This is not to say there’s no case against Bank independence. You might argue that it entrenches anti-austerity ideology by reinforcing the notion that aggregate demand must be suppressed. And it’s sometimes said (pdf) that it might cause a lack of coordination with fiscal policy. Personally, I don’t find these arguments convincing. Shifting control over rates back to the Treasury won’t in itself overturn anti-austerity ideology. And in recent years the obstacle to fiscal-monetary coordination has been the zero bound rather than Bank independence. But this debate doesn’t matter: the Tories aren’t arguing along these lines.

Of course, the Bank has made policy errors. But these are inevitable, simply because the economy is unforecastable. There’s no reason whatsoever to suppose that the Treasury would avoid such errors. In fact, pre-1997 history suggests it has been at least as error-prone as the independent Bank.

These attempts to undermine Bank independence are therefore without merit.   

I fear, though, that what’s going on here isn’t a narrow matter of macroeconomic management. There might be more to it. The idea that the government knows better how to set interest rates is part of a pattern. It’s part of the same mindset that thinks the government has the capacity to negotiate good trade deals, or the ability to enforce sensible immigration controls.

This is the same mindset behind the Brexit slogan, “take back control” -  the urge that government must be in control. From this perspective, an independent central bank is much the same as European judges – an unwanted constraint upon government power. When Ms May spoke of a desire to have “our judges sitting not in Luxembourg but in courts across the land”, I doubt she was calling for a strong independent judiciary.

The kindest thing one can say about this is that it over-estimates state capacity. But it might be more sinister. If we read these attacks upon independent institutions alongside demands to silence “unpatriotic” Remainers, what we’re seeing is a step away from liberty and towards totalitarianism.

Comments

[e]

"she has the means to do so" obviously. Talk is for their mass voter audience. Who's fault is all this? Question asked and answered..

[gastro george]

Isn't it just yet another short-term political manoeuvre by the Tories - to try to blame somebody else for the state of the economy?

[Ralph Musgrave]

Gastro George, You hit the nail on the head.

[aragon]

My very long post appears to have gone missing?

The truth is the opposite of Chris's conclusion.

Long/Short:

Independent = Unaccountable institutions.

World: IMF, World Bank, ISDS.
Europe: Bundesbank, ECJ, Brussels.
UK: BoE - Independent Central Bank.

The public can remove politicians, but not these, national/regional/international institutions.

William Hague made criticisms of QE.
But politicians have no power to prevent the BoE implementing policy through QE, without removing the independence of the BoE.

Control of the economy has been transferred to independent (unaccountable, unresponsive and remote institutions) with disastrous consequences.

The neo-liberal conscientious is set in international treaties and institutions beyond democratic control.

[JF]

Please address what an 'independent' regulatory agency can do to help basic savers, real people's thrift, to be paid higher earnings? Did you miss this policy objective which is at least not tone-deaf about society's interest in prudent people saving for precautionary or other reasons.

I do not know if by-rule depository institutions could be ordered to pay more by the central bank (and lower fees, so backdoor offsets arent simply done to avoid the policy's purposes) but that woukd be one clear, direct way to do that while signaling that government actually cares about the far larger number of people in society who do need to practice basic thrift, when they are able. It is ok to signal that your govt cares about this, and indeed will do something to make sure that privileged institutions do not take advantage or gain by penalizing this basic thrift. What indeed does the public's law say about the authority to effect such a thrift-support policy, is the central bank independent and can do this policy anyway, whether there is public law authorization or not?

So independence is a reason to use theoretics about money, savings and Investment so it can remain tone deaf?

My idea of independence would have a central bank leader publicly speaking out about the lack of a proper public policy about thrift (perhaps other matters). But that takes some moral courage to speak out. Tone deafness, cloaked in theoretic leger de main, well, that is easier isnt it.

[chris]

@ Aragon: the government DOES have the power to stop QE and raise rates. A big relaxation of fiscal policy would reflate the economy sufficiently to allow QE to end and rates to rise.
@ JF - I suspect you might have a point, that a long period of nugatory real rates would diminish the culture of thrift. But low real rates are not the fault of the Bank. They're the result of secular stagnation and an inadequate government response thereto - namely too tight a fiscal policy.

[aragon]

Who is in charge and how do they co-ordinate?

What if the BoE like the IMF regards the fiscal multiplier to be less than one, they may still think the economy requires QE.

Given multi-value, multi-attribute, stimulate/ inhibit (in varying degrees) it could get complex.

The Government and the Bank may be Over/Under stimulating/inhibiting, or even acting (dynamically) against each other as they have a different view of the economy, or the economy displays: lags, hysteresis, overshoots, uncertainty etc.

[Bob]

Carney should go further and tell the public that the only constraint on spending is real resources. The monetary policy game is not delivering, for the fairly simple reason that monetary policy is just a smokescreen and fiscal policy is what delivers the outcome - interest rates go up, government cuts back on spending, interest rates go down government increases spending.

But we now know we can do all that without interest rates going up and down. We can just leave base rates at zero and run the economy in a functional finance manner - largely via the auto stabilisers but with decent government investment spending.

[Mark]

It's true that inflation has been below target since 2014. Setting aside questions of whether the target in question is appropriate, it may be that the shortfall has been caused by a lack of fiscal loosening, rather than monetary policy.

Solving this problem is easy: both monetary and fiscal levers should be controlled by the same hands. But should those hands be a central banker's, or a politician's?

May is suggesting the latter. But the rationale for removing economic decisions from politicians remains solid: they may game elections by mistiming economic expansion.

The solution could therefore be to move fiscal policy to the Bank of England, rather than taking monetary power from it. Keynes would almost certainly approve: the -ism that bears his name has been unfairly discredited by generations of politicians who like the idea of expansion in difficult times but are reluctant to carry the electoral can for constraining growth with counter-cyclical tightening.

[Bob]

"The solution could therefore be to move fiscal policy to the Bank of England, rather than taking monetary power from it."

Well you can go screw yourself.

This again. Time inconsistency bullshit should be met with a Wray of light -:)

http://www.levyinstitute.org/publications/a-post-keynesian-view-of-central-bank-independence-policy-targets-and-the-rules-versus-discretion-debate

[Bob]

"Keynes would almost certainly approve"

Keynes is dead BTW.

* should have been a :-)