Central bank independence feels the heat - for unlikely reasons

LONDON (Reuters) - Damned if they do, damned if they don’t.

Arrangement of various world currencies including Chinese Yuan, Japanese Yen, US Dollar, Euro, British Pound, Swiss Franc and pictured in Warsaw, January 26, 2011. REUTERS/Kacper Pempel/Files

History is filled with governments pressuring central banks to underwrite boom times and political largesse with easy credit - so it’s peculiar that monetary policymakers’ long-prized operational independence is now being questioned because they left interest rates too low.

Economists have fretted for years that more than a decade of extraordinary central bank policies - which have suppressed the cost of government borrowing via bond-buying money injections - may end up compromising the ability of central banks to fight inflation whenever it reared up again.

The fear was that if monetary authorities were suddenly required to ratchet up interest rates and wind down balance sheets to rein in inflation, they may demur due to the risk of destabilising bond markets while facing political pressure not to squeeze national Treasuries and economies too hard.

But as the pandemic shock saw a doubling down of both outright bond buying and joint monetary/fiscal rescues in the major economies and now a subsequent inflation surge to 40-year highs, that test of nerve has come quicker than many suspected.

And yet the first political shots across the central bank bows appear to be coming for the opposite reason.

The Bank of England - which celebrated just 25 years of operational independence from government this month - has started to feel political heat for not raising interest rates faster and sooner than the four modest hikes to 1% that it’s already executed since November.

With a cost-of-living crisis of raging energy and food bills and falling real incomes seemingly a bigger priority, some government officials appear to be deflecting the blame on to the central bank - questioning the bank’s competence and independence in scattered press reports.

The government-leaning Sunday Telegraph newspaper this week splashed a front page story with unnamed cabinet ministers criticising the bank’s performance in keeping inflation down and quoting one minister claiming government figures were “now questioning its independence”.

Publicly, it’s a different story of course. UK finance minister Rishi Sunak on Tuesday told parliament there were no plans to restrain the independence of the Bank and an average UK inflation rate of 2% over the 25 years of its operational mandate spoke for itself.

Yet, BoE chief Andrew Bailey is undoubtedly under some pressure over what the bank could have done or should do now - being forced to deny the central bank was “asleep at the wheel” during a parliamentary grilling on Monday.

Having this month forecast 10% UK inflation by year-end and a possible recession through 2023 and on Monday spoken of “apocalyptic” world food price rises, Bailey has not endeared the bank to nervy masters in Westminster.


Columbia University professor and former BoE policymaker Willem Buiter thinks all this pressure on the bank to do more rather than less to zap the cost of living crisis is “ironic” against traditional fears for central bank independence.

“I don’t think there is an easy way out of this quandary for the Bank,” he said. “If they tackle inflation more aggressively they will likely get it in the neck from household and corporate borrowers exposed to higher interest rates and reduced appetite for additional debt.”

But he said there were reasonable questions of competence for all central banks given how long it took them to act.

Now, Buiter added, the popular appetite to fight inflation first and foremost may give U.S. and UK central banks something of a green light to push harder, leaving market expectations of 2.5-3.0% peaks for the cycle well shy of reality.

While the BoE may be operationally independent, he said, the legal avenues of political influence were still numerous over time - policymaker appointments, inflation target setting and even the ability of government to overrule some decisions.

Central bank criticism seems quieter in other G7 economies - but political angst over tackling high inflation is significant.

U.S. Federal Reserve chief Jerome Powell faced constant public barracking from former U.S. President Donald Trump over what Trump said was his ‘clueless’ tight policy stance relative to other economies. However, he received bipartisan support in the Senate this month for his renomination for a second term by President Joe Biden.

But Biden’s statement also made it clear that lowering decades-high inflation rates was the top domestic policy priority and up to the Fed to sort out.

The younger multinational European Central Bank is a different beast. But it too is seeing pressure from its more hawkish German and Dutch members to move quicker to lift interest rates back into positive territory.

Buiter thinks more traditional independence worries still reside with the ECB and an extended period of ‘fiscal capture’ there associated with heavy buying of less creditworthy euro government debt “on a scale that cannot but threaten price stability”.

In the end, few governments will likely want to tamper with such important institutional setups until the tumult from unforeseeable events like the pandemic and now the war in Ukraine eventually subsides. Many may even privately welcome ‘independent’ scapegoats.

More considered judgement on whether independence led to overly lax monetary policy may have to wait for the next big economic downturn. If a late start to tightening does eventually mean much higher interest rates for longer in that environment, the recriminations may get louder.

The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own

by Mike Dolan, Twitter: @reutersMikeD; Editing by Emelia Sithole-Matarise