The Politics of Independent Central Banks

Central banks have long played a far larger role in policy-making than their legalmandates might imply. In recent years their power and influence have become even greater. Since the financial crisis, public banks around the world have taken on more direct responsibilities for financial supervision and regulation, and pushed monetary policy to new limits in order to stimulate the global economy. In the United States and Eurozone, in particular, political barriers have limited legislative responses to the crisis, forcing regulatory institutions to pick up the slack. As a result, central banking institutions today possess broader policy-making authority and discretion than they possessed a decade ago. With greater power comes greater responsibility and, in the world of academia, greater scrutiny. In recent years, a number of books have challenged some of the idées reçues on central banks. Chief among the critical targets has been a set of theories, influential in policy-making circles since the inflation-ridden economic crises of the 1970s, extolling formally independent central banks as the best (if not only) way for governments to maintain price stability. Such theories argued that, since elected officials would always be incentivized to use monetary policy powers to gin up the economy preceding an election, leaving monetary policy to the discretion of elected officials would produce an inflationary bias. Only formally independent institutions, freed from the influence of the short-term election cycle, could make the ‘credible commitments’ necessary to maintain price stability. In the 1980s and 1990s, a number of studies found correlations between low inflation and independent central banks (e.g. Alesina and Summers 1993). In the same period, many states established formally independent banks, particularly in Europe. The EU even enshrined the principles of Central Bank Independence (CBI) and a commitment to low inflation in the 1992 Maastricht Treaty.