Independent Central Banking and the Other Great Moderation

Has independent central banking jumped the shark? That’s the question Dan Drezner poses to his readers, in response to this op-ed from Pascal-Emmanuel Gobry arguing that central banks’ collective failure during the Great Recession should encourage us to return to more political central banking. This is actually a topic I spend a fair bit of time thinking about, and indeed wrote about back in January when Hungary was considering a shift away from independent central banking. I won’t rehash what I said then, but here are two additional thoughts on the question:

– The first is that Drezner is spot on in emphasizing that the dichotomy between “independence” and “political control” isn’t really all that clear cut. I think as societies we should be having more open and engaged discussions about monetary policy and the normative, distributive questions surrounding the inflation/unemployment trade-offs. These issues matter a lot, and when central banking is viewed as a purely technical domain they tend to fade to the background, allowing certain groups – generally the financial class – to quietly shape these debates in their own interests; it’s far better that they be addressed consciously and out in the open. But it’s not clear that this means central banks should be more closely under the thumb of our legislative institutions, and I’m particularly not eager to give the current US Congress much more power over monetary policy. To put it another way, there are a lot of issues that I think are overpoliticized in contemporary Western society – global warming, religion, culture, etc. Monetary policy is one of the rare issues which is underpoliticized; particularly with the current state of the economy, debates over monetary policy should play out not just in economics blogs but amongst the public in broader society. Like supreme courts, central banks shouldn’t necessarily be closely controlled by elected politicians, but they should be more engaged in their societies and reflect the interests and demands of the general public, including over contentious distributive issues.

– The second point is that when judging the value of independent central banking as a concept it’s worth looking beyond just the OECD countries and to the developing world as well. One of Gobry’s key points is that the financial crisis has revealed that the Great Moderation – the reduction in business cycle volatility in Western economies since the mid-80s, hailed as the great success of independent central banking – was something of a mirage. Now maybe this is true and maybe it isn’t, but it’s worth pointing out that the concept of independent central banking also deserves considerable credit for what I might call the Other Great Moderation, the one which took place in the developing world. Simply put, the quality of monetary policy has greatly improved across the developing world over the last couple decades, underpinning the widespread economic success of developing countries in recent years. As with the Western Great Moderation, there are a lot of potential explanations for this development, but the greater independence of central banks is a pretty big part of the story. And importantly, unlike the Western Great Moderation, the Other Great Moderation appears to have survived the crisis intact.

Here’s the Other Great Moderation in one graph, showing the share of developing countries with inflation above 20 percent and above 80 percent from 1980 until today (data from the IMF’s latest WEO):

Back in the 1980s it was common for about a quarter of developing countries to be experiencing average annual inflation above 20 percent, and for a non-negligible number to see inflation above 80 percent. In the early 90s, with the crisis in the former Soviet Union, these figures picked up considerably. Since then, however, episodes of high inflation have declined dramatically, and except for a small bump during the 2008 crisis have all but disappeared. (Two small asides on the graph: First, the thresholds were rather arbitrarily selected, but as a quick robustness test I also tried other levels for “high” and “very high” inflation, and the picture always looks about the same. Second, it’s worth noting that because of data availability issues and the changing number of countries in the world (i.e. FSU), I had to make the graph the share of developing countries with high inflation rather than the absolute number, and this probably understates how big the change has been, as I imagine the countries missing data in the early period systematically have higher inflation than the rest of the sample.)

I don’t necessarily think this fact should hugely weigh on debates about whether to preserve independent central banking in the West, other than perhaps as a reminder that what really matters is the interaction between the independence of the central bank and the general quality and competence of political institutions. But I do think it’s very important for our understanding of the value of central bank independence as an abstract idea, and should be noted before we start writing a eulogy for independent central banks.


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