Central View: The Global Battle Over Central Bank Independence


James Bullard

Financial crisis aftershocks have partially broken down the consensus on the wisdom of central bank independence. They have introduced a “creeping politicization” of central banking globally. To the extent that central bank independence is weakened globally, macroeconomic stabilization policy will not be executed as well in the future as it has been since the mid-1980s. “Fiscalization” of monetary policy will tend to complicate the policymaking process substantially.

Consensus on Central Bank Independence

Effective macroeconomic stabilization policy has to be implemented in a timely manner in reaction to macroeconomic shocks. Adjusting fiscal policy—taxation, appropriations and public debt—as a means for stabilization tends to be slow and must be carefully negotiated, while monetary policy can be implemented in a timely and technocratic manner. Hence the conventional wisdom: Focus fiscal policy decisions on the medium and longer run and delegate monetary policy to an independent authority.

If monetary policy is not delegated to an independent authority, then it too becomes part of the slow and complicated negotiations associated with fiscal policy. The society would be left without a way to make timely policy adjustments in reaction to macroeconomic shocks, and the result would be more macroeconomic volatility. The consensus therefore suggests that macroeconomic outcomes will be better with an independent central bank.

Fiscal Responses

In recent years, the central banks in the G-7 countries encountered the zero lower bound on nominal interest rates. In my view, central banks have conducted stabilization policy effectively even while at the zero bound, primarily through the use of quantitative easing programs and forward guidance. Nevertheless, many see fiscal stabilization policy as desirable in the current context.

One idea suggested by some is that the central bank take actions that are cumbersome to accomplish through a democratically elected body, which may be seen as one way to get the relatively speedy monetary policy decision-making into a fiscal policy context. However, this is a creeping politicization of monetary policy. In such a case, some central bank independence is lost since the monetary authority is taking actions at the behest of other policy actors. Furthermore, monetary policy decisions then become wrapped up with fiscal policy decisions, slowing down the process through negotiation and making it considerably more complicated.

ECB’s OMT Program

An example of this creeping politicization trend is the European Central Bank’s (ECB’s) outright monetary transactions (OMT) program, which has been widely interpreted as a promise to buy the sovereign debt of individual nations. Should purchases occur, they are conditional on the nation meeting certain fiscal targets.

This is fiscalization of monetary policy: asking the central bank to take actions far outside the remit of monetary policy. Assistance like this from a central authority to a region is best brokered through the political process in democratically elected bodies. The ECB is in essence substituting for a weak pan-European central government.

By nearly all accounts, the European monetary policy process has been bogged down by political wrangling over the OMT and other programs. Ordinary monetary policy provides or removes monetary accommodation in response to macroeconomic developments. Yet the ECB has taken little direct action in response to the European recession.

By conducting a fiscal action, the central bank has been pulled away from its ordinary macroeconomic stabilization policy. Standard monetary policy has become wrapped up in the fiscal policy package and subject to the negotiations that surround that package. This defeats one of the original purposes of central bank independence: having a monetary authority that can react to macroeconomic shocks quickly and effectively.