Time for a rethink on central bank independence?

There’s some very interesting stuff going down in Hungary right now. The politics of it are complicated and I won’t pretend to completely understand all of it (see Edward Hugh here for a nice recap), but in brief at the end of the year the Hungarian government, in defiance of the EU, passed a law that limited the independence of the central bank, subsequently suffered a credit downgrade and a spike in borrowing costs, and now looks to be in need of IMF support. The IMF (backed by Brussels) is likely to make repeal/adjustment of the law a prerequisite of any such support, and so the Hungarian government seems to be preparing to backtrack out of necessity.

This isn’t the only case of central bank encroachment of late. Cristina Kirchner took on the Argentine central bank in 2010 over whether or not to use reserves to pay off debt (and largely came out the victor), while in the US Ron Paul and the “End the Fed” crowd (as well as the milder “Audit the Fed” crowd) have never been so popular.

Central bank independence is about as sacred a tenet as you can get in economics, but – while I don’t necessarily want to associate myself with the above characters – I do think now is a particularly valuable time to revisit this issue. In a Washington Consensus world where it seemed obvious that central banks should be targeting 2% inflation, central bank independence had a lot going for it. But things are a little more complicated today. For one thing, there’s a strong case to be made that some above average inflation is the best (only?) policy prescription available today for helping lift us out of the downturn, and could particularly be a boon in trying to get production costs under control in Greece and Spain. And even when we look out at the longer term, the 2% inflation target seems to be losing some of its appeal – none other than Olivier Blanchard openly discussed the idea of a 4% target a little while back. Critically, these aren’t just issues of pareto efficiency; they’re very normative issues which impact distribution, pitting savers vs. borrowers (not to mention Germans vs. Greeks), and can considerably tilt the field towards or against various economic actors and industries. In other words, picking an inflation target is an inherently political decision, producing winners and losers. Moreover, as the mission creep of central banks expands into financial regulation (and beyond?) the normative, political questions only get thornier.

Central bank independence, while it brings many benefits, tends to obscure this fact. When central banking is widely viewed as a purely technical domain, those who exert influence over central banks (more often than not the financial class) can silently shape these political decisions to their own benefit. Maybe this is a price worth paying to keep politicians from turning on the spigots before an election; but maybe not. In any case, now seems like a good time for this discussion.

Occupy Wall Street is still looking for an issue to rally around: how about calling for a serious political debate over what the inflation target should be?


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  1. 1 Independent Central Banking and the Other Great Moderation « Tomorrow's Economy Trackback on May 30, 2012 at 12:34 pm

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