Sometimes, battles have to be fought again. So it seems with central bank independence, because the consensus that operational independence is a good thing has come into question. In a series of tweets last month, President Trump demanded a “big cut” from the Fed, saying that chairman Jay Powell has “only let us down”. To this, Bill Dudley – a former member of the Federal Open Market Committee – replied that the Fed should not bail out Mr Trump’s bad trade policies and reject any policy that would help his re-election.
It’s worth, therefore, reminding ourselves of why economists agreed for a long time that some degree of independence was a good thing. Their thinking was that a political central bank would cut interest rates before an election, thus stoking up inflation. This would cause inflation expectations to be higher than they would otherwise be, which would cause actual inflation to be higher on average. Output growth, however, wouldn’t be much different because the pre-election boom would be followed by a recession as central banks raised rates to choke off inflation after the election. Political central banks would therefore deliver higher inflation than others, but no better growth. And the data supported such a view. In a paper in 1994 – which influenced Labour’s decision to give the Bank of England operational independence – Guy Debelle and Stanley Fischer wrote that “central bank independence appears to have no adverse consequences”.
In challenging this consensus by leaning on the Fed, President Trump is jeopardising the non-inflationary growth that independent central banks have delivered.
But, but, but. Although some forms of opposition to central bank independence are just stupid, others are not. There is a genuine problem across developed economies. It is that interest rates are so low that conventional monetary policy – cutting rates – will be insufficient to fight the next recession. And with bond yields low (and negative in Europe) orthodox quantitative easing – buying bonds – is unlikely to do much good either. Central banks therefore need new tools.
One such option is so-called helicopter money, or people’s quantitative easing, whereby central banks – instead of handing money only to financial institutions – give people money directly. Most forms of this, however, require coordination with governments, if only because the government knows where you live while the Bank of England doesn’t. If the government borrows money to cut taxes and the Bank then immediately buys the bonds issued to finance the cut, the Bank is in effect printing money to hand over to the public.
There’s a dreary debate about whether this is fiscal or monetary policy. Whichever it is, however, the fact is that such new tools require coordination between governments and central banks and therefore a reconsideration of the current nature of banks’ independence. Given that we can’t predict when central banks will need such policies, such a reconsideration should happen soon.
President Trump’s challenge to central bank independence might be oafishly clumsy, but there is a serious issue here.
