What might they have been thinking at the central banks of Canada, the United Kingdom and the United States on December 10 when they received word of Reserve Bank of India (RBI) Governor Urjit Patel’s resignation?
The abrupt departure marked the end of a power struggle between the RBI and its political masters; for two years, India’s central bankers and government have been at odds over the regulation of banks. In 2016, Prime Minister Narendra Modi’s government ran former RBI Governor Raghuram Rajan out of town and replaced him with Patel. The result: within only a few years of adopting a formal inflation target, the RBI has been robbed of the operational independence it needs to fulfill its mandate. There is little reason to think that Shaktikanta Das, the new governor, will have the autonomy to make unpopular decisions when the time comes.
Patel’s fate must resonate with his former counterparts at other big central banks. The leaders of the Bank of Canada, the Bank of England and the United States Federal Reserve (Fed) all experienced political turbulence of their own in 2018. In each case, it seemed as if the central banker’s only offence was forgetting who appointed him.
Canada’s Stephen Poloz, the surprise choice of former Conservative Prime Minister Stephen Harper in 2013, clashed in April with a Conservative senator who chastised him for speaking favourably of the current Liberal government’s efforts to narrow the gap between the number of men and women in the labour force.
Mark Carney, the head of the Bank of England and Poloz’s predecessor, was dismissed as a “second-tier Canadian politician” by a member of the governing Conservative party who disliked the bank’s forecast of what would happen if the United Kingdom failed to secure a peaceful departure from the European Union.
Jerome Powell, the Fed chairman, has endured repeated attacks this autumn from US President Donald Trump, who chose Powell over the popular incumbent, Janet Yellen. “So far, I’m not even a little bit happy with my selection of [Powell]. Not even a little bit,” Trump told The Washington Post on November 27. “I’m not blaming anybody, but I’m just telling you I think that the Fed is way off-base with what they’re doing.”
Bloomberg News counted 17 central banks that have experienced an unusual amount of political interference in 2018. The list includes the RBI, which pushed back against the Modi government’s meddling, ultimately in vain; the Central Bank of the Republic of Turkey, which had to fight off a currency crisis linked to overt pressure from President Recep Tayyip Erdogan to keep borrowing costs low; and the Reserve Bank of New Zealand, which was ordered earlier this year by the new government of Prime Minister Jacinda Ardern to add an employment goal to its inflation target.
The idea that central banks should be left alone emerged alongside the embrace of rational expectations theory in the 1970s and 1980s. Economists such as Robert Lucas, Edward Prescott, and Finn Kydland argued that policy makers would struggle to convince the public they were serious about containing inflation if politicians retained a say on setting interest rates. In 1993, economists Alberto Alesina and Lawrence Summers published research that suggested the theory worked. By the late 1990s, there was a broad consensus that central banks should be allowed to operate at a safe distance from the political centre, and that politicians should avoid saying anything that could be construed as an attempt to influence monetary policy. A couple of decades of relatively steady, inflation-free economic growth helped turn an academic consensus into a convention of democratic governing.
The 2008 financial crisis dealt a blow to conventional wisdom. The prophets of inflation targeting paid too little attention to financial stability. Central banks had become highly visible, at first because they were given credit for the good times, and then because they struggled to orchestrate a quick recovery from the Great Recession. Policy makers such as Ben Bernanke, the former Fed chairman; Mario Draghi, the current president of the European Central Bank; and Carney distinguished themselves during the crisis and its aftermath. They also became targets.
Some political leaders disliked sharing the spotlight with their popular central bank chiefs. Populists — including Trump and the hardcore Brexit wing of the British Conservative Party — found success in showing disdain for technocratic expertise and existing norms. The bitter politics of recent years may eventually burn itself out. But how much damage will be caused before that happens? Central bankers await 2019 with trepidation.
“There’s a concern among the central banking community that the independence of central banks could be under threat,” Lesetja Kganyago, governor of the South African Reserve Bank, said at the end of November. “If politicians got their way on that one, they may just decide to go for the judiciary and then go for the next institution and then the next institution.”
Do central banks have a choice but to await what comes? Maybe. They could confront the political pressures they are facing and lead a debate on how central bankers and politicians should interact in a post-crisis world.
In October, The Economist magazine’s “Free Exchange” column argued that it was time to stress test the idea of central bank independence.
One reason to do so is to end the myth that the people who set interest rates are somehow above politics — they aren’t. Sebastian Mallaby’s 2016 biography of former Fed chairman Alan Greenspan shows that the most revered central banker of modern times was political to his core. Carney’s move to the United Kingdom was coloured by denials that he wanted to leave Canada and innuendo about his interest in joining the Liberal Party. The Bank of Canada’s board of directors is nominally in charge of choosing the governor, although few believe it works that way; the Harper government made clear in 2013 that it also would be interviewing the board’s shortlist to replace Carney before making the final selection. And when Trump was asked why he didn’t reappoint Yellen, has said he was attracted to the idea of having his own people running the Fed.
The other reason to rethink central bank independence is that the mission might have changed since the era of Summers’s and Alesina’s research. Inflation in many countries appears stuck at low levels, suggesting interest rates will remain relatively low. And with low interest rates comes greater risk of asset-price bubbles as yield-hungry investors take greater risks. Central banks will have less ammunition to fight the next economic downturn and will likely call on finance ministries for help: targeted macroprudential regulatory measures to deflate bubbles, fiscal stimulus to stoke demand, or both. None of this means central banks should be neutered. But if macroeconomic management now demands a greater level of cooperation, then any walls between monetary and fiscal authorities will be unhelpful. Central banks will need to be seen as accountable to the public so they can engage with the government as equals, rather than supplicants.
Central banks are already thinking about this question, if quietly. For example, the leaders of the Bank of Canada are intrigued by the possibility of a more systematic approach to generating a better “policy mix,” which is the way they talk about the possibility of achieving a more optimal balance between interest rates, fiscal stimulus and regulatory measures. Poloz wrote a paper about it in 2016; Carolyn Wilkins, the senior deputy governor, talked about it in 2017; and the idea was top of mind earlier this year when a reporter asked her to reflect on the tenth anniversary of the financial crisis. “There are a couple of areas where more work needs to be done,” Wilkins said at a September 6 press conference in Regina, Saskatchewan. “One area is thinking about how macroprudential policy can work with monetary policy when you have low interest rates.”
Central bankers and their respective finance ministers would have to spend more time together to ensure they got the policy mix right. The independence of the interest-rate setters could be preserved — and improved — by making them more accountable to the legislature. First steps include a more transparent appointment process and more regular scrutiny on monetary policy makers by parliamentarians. Central bankers might prefer the old days of sparring with presidents and prime ministers behind the scenes. Alas, those days might be over.