Larry Summers wrote this piece recently, marking the 20 year celebrations of independence for the UK’s Bank of England, explaining why he thought the case for central bank independence was now weaker than in the past. I am going to push back on his arguments, one by one. Larry writes: “..after a splurge of indiscipline following the breakdown of Bretton Woods, politics seem to have internalized anti-inflation norms so insulation from politics is less important. It is noteworthy that in the US, Europe and Japan political criticism of central banks comes much more from the hawkish side than the dovish side.” In the UK, the fracturing of the cross party consensus on monetary policy seems more symmetric. Recall the Corbyn-McDonnell leadership campaign which pushed Richard Murphy’s
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Larry Summers wrote this piece recently, marking the 20 year celebrations of independence for the UK’s Bank of England, explaining why he thought the case for central bank independence was now weaker than in the past. I am going to push back on his arguments, one by one.
“..after a splurge of indiscipline following the breakdown of Bretton Woods, politics seem to have internalized anti-inflation norms so insulation from politics is less important. It is noteworthy that in the US, Europe and Japan political criticism of central banks comes much more from the hawkish side than the dovish side.”
In the UK, the fracturing of the cross party consensus on monetary policy seems more symmetric. Recall the Corbyn-McDonnell leadership campaign which pushed Richard Murphy’s idea of ‘People’s Quantitative Easing’; and McDonnell’s previous hostility to the Bank of England, which he viewed as an agent of the establishment. And note the new controversy, with protagonists on the left and the right, over whether monetary policy should target inequality.
Moreover, central bank independence is not just about insulating monetary policy from ill-advised inflationary politics; it is to protect it from equally misguided hawkishness. Without that protection, central banks might not have been able to keep interest rates low for so long or experiment with money-creating quantitative easing.
“Second, the problem of this era in most countries is too little inflation not too much. The United States, Europe and Japan have all fallen short of their inflation targets for close to 10 years now. And judging by the index bond yields, inflation will average well below target for the next 10 to 20 years.”
Two replies. i) Repeating my point above, throwing monetary policy to the wolves of politics again might well condemn inflation to be too low for much longer than otherwise, if by weakening central bank independence price stability hawks got more control. ii) Summers’ argument could be read as ‘the horse is asleep; no danger of it bolting, so leave the stable door open.’ If central bank independence does no harm [see below] it should be kept in place to prevent the inflationary horse from bolting again, if it were to wake up.
“much of the best contemporary thinking about the liquidity trap emphasizes the credibility issue with respect to central banks being willing to accept inflation after the economy recovers. Structural insulation of central banks likely reduces this credibility.”
This is not an argument against independence per se, but against allowing central banks to define their own monetary policy goals. Provide goals are set by the finance ministry, and central banks are held accountable if they generate insufficient inflation, there should be no problem.
“new institutional arrangements in which it is normal to pay interest on reserves reduce the concern that a non-independent central bank can be forced to enable excessive deficits through monetization. Money in the current environment is essentially equivalent to floating rate government debt so money finance involves much smaller savings than was once the case.”
True enough. But there is no reason why monetary policy might not revert to the old method, without paying IOR. The main [but not only] reason for moving to IOR was to allow central banks to put a floor to the policy rate above zero, at the same time as engaging in massive asset purchase programs. Since this thinking, several central banks have shown that one can cut rates actually below zero without devastating banks and other intermediaries. And at some point policy will normalise, shrinking balance sheets back to ‘normal’ and removing the need to encourage the market to hold excess reserves.
Summers writes about how central bank independence complicates coordination with the fiscal authorities:
“Fiscal monetary cooperation is a much more significant issue when an economy is in the liquidity trap, near the liquidity trap, or facing the possibility of getting into the liquidity trap at some point in the future. When monetary policy cannot sterilize impacts of fiscal policy on demand, there surely should be coordination of fiscal and monetary policy.”
This is true. However, fiscal policy has not been universally ideal during the liquidity trap, either in the US or the UK, were in both cases one can make a very good case that it was too tight. One could instead make a decent argument for allowing limited and coordinated delegation of fiscal policy to technocrats. For instance, I suggested before that if a zero bound episode either threatened or was being experienced, central banks be instructed to quantify the missing stimulus that the zero bound implied, referring back to the Treasury the job of how to design a stimulus program to replace that stimulus [if it chose to take the advice] and the Office for Budget Responsibility the job of adjudicating on whether the stimulus plan did the job intended and was consistent with long term sustainability.
“Debt management policy where QE operates by shortening the maturity structure of the debt that a country’s creditors have to hold. The impact of QE is essentially the equivalent of changes in the maturity structure of a country’s debt accomplished through altered patterns of issuance or buybacks. It makes very little sense for debt maturity policies for one country to be set separately in two places.”
True. But coordination could be achieved here either by delegating debt management back to the central bank [as was the case in the UK before 1997]; or by providing for codified control over the maturity mix during the lifetime of a central bank asset purchase program.