The central bank independence myth continues

One of the enduring myths that mainstream macroeconomists and the politicians that rely on their lies to depoliticise their own unpopular actions continue to propagate is that of ‘central bank independence’. This is the claim that macroeconomic policy making improved in the ‘neoliberal’ era following the emergence of Monetarism because monetary policy was firmly in the hands of technocratic bankers who were not part of the political cycle. As such, they could make decisions based on fundamentals rather than the requirements of the political cycle. The corollary was that vote-greedy politicians, who operate on short-term political cycles, would be willing to compromise the ‘longer-term’ health of the economy to splurge on populist programs that might increase their chances of re-election. As a result of the mismatch between the political cycle and the, longer, economic cycle, the neoliberal solution was to make monetary policy independent of the political cycle. Except, of course, it didn’t and cannot. The latest scaremongering about the ‘loss’ of central bank independence was published in the UK Guardian last week (February 28, 2020) – From the Fed to Bank of England, central banks must up their game. The author is a former deputy governor of the Bank of England Board and former director general of the CBI. The interesting point about the article was not the further elaboration of the myth, but, rather, his assessment that the chances of reforming the European Union treaties in any direction “are vanishingly small”. Read: zero. From the mouth of the elites. I hope our Europhile Left colleagues absorbed that bit, at least.

I have written about central bank independence before:

1. ECB continues to play a political role making a mockery of its ‘independence’ (June 12, 2018).

2. Censorship, the central bank independence ruse and Groupthink (February 19, 2018).

3. The sham of ECB independence (October 24, 2017).

4. Trump might do us a favour – expose the myth of central bank independence (November 14, 2016).

5. The sham of central bank independence (December 23, 2014).

6. US Federal Reserve chairman loses his independence (April 28, 2011).

7. Central bank independence – another faux agenda (May 26, 2010).

The tenet of the UK Guardian article is straightforward.

The presumption is that central banks are ‘independent’ from the elected politicians who determine fiscal policy (government spending and taxation) and that recent trends – such as the rise of ‘populist’ leaders (when is the elected leader ever not populist?) such as Donald Trump – are threatening to compromise this ‘hallowed’ state.

The presumption is wrong and so all the rest of the analysis that follows from it is thus reflective of the dominant depoliticisation ideology that is one of the central characteristics of neoliberalism.

The deployment of depoliticisation has allowed elected governments to divert responsibility to ‘external’ agencies or ‘independent’ central banks for the harsh policy regimes that have undermine our material standards of living and retrenched public services.

The British Labour Party certainly were early practitioners when Dennis Healey lied in the mid-1970s about having to borrow money from the IMF because the British government had run out of funds.

He really wanted to impose austerity and not destroy the Social Contract with the Trade Unions but had to work out a way to shift the blame. Who better than to use the IMF as the ‘external’ agency forcing Britain to do something bad.

It wasn’t me it was them!

The same holds for the central bank independence myth.

Elected governments wanting to pursue the redistributional characteristics of fiscal austerity (shifting income to the top end of the distribution) have been able to claim that monetary policy is the only ‘effective’ macroeconomic policy tool in normal times and that interest rate changes are the sole responsibility of the various monetary policy committees.

And if interest rate rises are unpopular, then you know who to blame.

It wasn’t me it was them!

Except, the ‘them’ are not accountable to the people via any normal democratic process.

And this all ties in then, to the rising democratic deficit in our nations during this period of neoliberal blight.

So, Howard Davies (the UK Guardian author) is keen to maintain the claims that any step back from ‘independence’ is like having “a fox in charge of the chicken coop”.

In other words, bad!

He also implicates politicians he doesn’t like via their alleged attempts compromise the ‘independence’ – Trump, Recep Tayyip Erdoğan, Narenda Modi, etc.

But promotes characters he likes – such as Mario Draghi as people who “issue a firm defence of the concept” – that is, of independence.

Except at that point, his grasp on history rather tenuous.

The ECB was a major part of the Troika. I will come back to that.

Why do I say that central bank independence is a myth?

First, clearly, as the UK Guardian article points out, elected politicians appoint the management boards of central banks including the governors.

That makes the flavour of the monetary policy boards reflective of the politics of the day.

As one former Reserve Bank of Australia governor noted in a speech in 1994 (Source):

Given that central banks are created by government legislation and derive their powers from such legislation, they cannot be completely separate from the government.

Second, in many jurisdictions, the Finance or Treasury ministers can overturn a monetary policy decision should they wish. There are various means through which this power can work.

The aforementioned Speech also noted that:

In Australia, the legislation provides that in the event of a dispute over monetary policy, the government can override the Reserve Bank by tabling its objections before both houses of parliament.

Third, and most importantly, on a practical or operational level, the central bank and the treasury functions have to be closely coordinated on a daily basis to ensure that the policy targets of each are capable of being met.

That alone compromises any suggestion that the central banks can operate separately from the political sphere, which determines fiscal policy parameters.

In my blog posts – The consolidated government – treasury and central bank (August 20, 2010) and Understanding central bank operations (April 27, 2010) – I laid out the core Modern Monetary Theory (MMT) argument that there is nothing to be gained from having central banks as separate institutions (note this is not the same thing as ‘independence’) from the treasury function.

The discussions trace the impacts of fiscal policy on the monetary aggregates that the central banks watch as part of their monetary policy operations.

In isolation, a national government fiscal deficit, which results from the government spending more (via crediting bank accounts and/or posting cheques) than it drains via taxation revenue from the non-government sector, results in an overall injection of net financial assets to the monetary system.

This boosts the so-called monetary base, which is made up of:

  • The currency (notes and coins) held by the public and issued by the government);
  • The deposits that the commercial banks have with the central bank – the so-called reserves;
  • The liabilities the central bank has to the non-bank financial intermediaries.

Conversely a fiscal surplus, which results from the government spending less than it drains via taxation revenue from the non-government sector, results in an overall withdrawal of net financial assets from the monetary system.

This reduces the monetary base.

In the former case, in isolation, the deficits add reserves to the cash system which are in excess of the levels desired by the banks for their clearing purposes and so they try to rid them via interbank market competition.

Unchecked, this process would drive down the short-term interest rates to zero and compromise a positive central bank interest rate target.

However, that is not what actually happens in reality – in most cases.

It is clear that the central bank sets the short-term interest rate according to its current policy aims and its expectations of likely movements in variables that influence its monetary policy formation.

In general, central banks:

1. Prevent reserve excesses through the use of open market operations (selling interest-bearing government debt to the banks in return for reserves – which drains the reserves back to their ‘desired’ levels).


2. Offer a competitive support rate on excess reserves to the banks which stems any urge to dispense them.

The two options are equivalent in terms of their impact and just result in different accounting.

In the second case, the support rate effectively becomes the interest-rate floor for the economy.

Central banks then manage the corridor or spread within which the short-term interest rates can fluctuate with liquidity variability.

They do that on a daily basis.

And, that essential liquidity management function has to be performed in close liaison with the treasury departments – so that the bank can understand what fiscal injections/withdrawals are coming up on any given day and the implications for the banking reserve system.

Does political interference constitute an abandonment of central bank independence?

The previously cited Speech from a former RBA governor noted that central bank “independence”:

… does not preclude Ministers from commenting on monetary policies, and it does not preclude central banks from consulting with the government on monetary and other policies.

This is a curious position to take.

If, politicians publicly denounce the current policy stance – think Trump’s recent statements – then monetary policy is being politicised.

But, more importantly, you will note that the former Governor failed to mention the opposite situation – where central bank boards comment on fiscal policy and/or actively become agents in the implementation of fiscal policy.

At that point, the sham of central bank independence is clearly exposed.

We have countless historical examples.

The ECB is clearly not legally constructed to enforce European Commission dictates with respect to the Member States about fiscal policy, labour market policy, product market policy or anything else like that.

It would be strictly illegal for it to become involved in those things.

Yet on August 5, 2011, Jean-Claude Trichet, the then President of the ECB, sent a letter to the Spanish Prime Minister José Luis Rodriguez Zapatero
demanding that the Spanish government push fiscal austerity harder, further deregulate labour markets and introduce measures to cut wages.

The letter is available from the – ECB – after it was reclassified for public release on December 19, 2014.

It demonstrates how involved the ECB was in pushing the Troika line, which is not the impression it gave back at the time and also demonstrates that the neo-liberal concept of independent central banks is another one of those myths that allow policy makers to deflect responsibility for poor decisions that damage the prospects of people.

We could also consider the ECB’s role in June 2015, at the height of the Greek stand-off with the European Commission. The ECB breached its legal obligation to maintain financial stability by threatening the Greek government with damage to the Greek banking system in the event that the government failed to tow the line on austerity.

It was clearly acting as a political agent.

More recently, in a different way, as the consequences of this era of monetary policy dominance is becoming more obvious – zero to negative interest rates, massive build up of central bank balance sheets due to holdings of government debt – it is clear the there is no major push back coming from central bankers, the financial markets and citizens for fiscal policy to become the dominance policy tool.

I have reported in the past how central bankers are now increasingly calling for the neoliberal bias against fiscal policy to be reversed.

Former Bank of England governor, Mark Carney told the Financial Times in January this year (Source) that:

… central banks were running out of the ammunition needed to combat a downturn … Mr Carney echoed other central bankers, such as the European Central Bank’s Mario Draghi and his successor, Christine Lagarde, in recommending that governments consider fiscal policy tools, such as tax cuts or public spending increases when tackling a downturn.

The current RBA governor has repeatedly demanded that that Treasurer abandon the Australian government’s obsession with pursuing a fiscal surplus.

These are all examples of central banks being significantly involved in the political process and compromises any hint that they are ‘independent’ of that process.

The most important contribution of the UK Guardian article

As noted in the Introduction, most of Howard Davies’ article was forgettable.

However, at one point he comments on the appointment of Madame Lagarde to the helm of the ECB saying:

In the eurozone, a similarly neutral choice emerged as Draghi’s successor and a change in the ECB’s status would require a new EU treaty. The chances of that are vanishingly small. EU leaders show no indication of taking the risk of opening up the constitution to further referendums, as would be necessary in some countries.

How is that for a statement from an ‘insider’ about the way the EU works.

He admits that the EU elites would not dare open up the Treaty to a vote by the people, because they know, as they did before the third stage of the Maastricht process was ratified, that the people would not support their neoliberal contrivance.

So, better to stick to the script that the Treaty is sacrosanct and that there is no prospect of reform.

Game, set and match.

This is exactly the end that Jacques Delors and his gang sought when they drafted the current Treaty and what the European Commission sought when they bulldozed the Treaty of Lisbon through after sensing the ‘democratic’ voice (in Denmark and France, for example) would not support their ambitions.

Yet, I see on Twitter and in other media, a relentless event schedule held by Europhile progressives where the latest ‘reform’ proposal is aired and lots of self-congratulatory Tweets espouse a new future for Europe.

Meanwhile back at the ranch – the reform prospects are “vanishingly small”.


Not a lot for a progressive person to look forward to in these sorts of discussions.

But we should be ever vigilant because some ‘socialist’ or Labour Party type here or in Britain or elsewhere will propose yet another ‘fiscal rule’ that elevates so-called ‘independent’ central banks to the top of the decision making hierarchy and grant the banks veto power over the elected treasury or finance minister.

That is exactly what the failed British Labour Party ‘Fiscal Credibility Rule’ actually intended. I hope the advisors who came up with that nonsense never get their foot in the policy making door in that nation again.

That is enough for today!

(c) Copyright 2020 William Mitchell. All Rights Reserved.

This Post Has 17 Comments

  1. Dear Bill,

    One aspect I do not understand is why the Oz banks are able to get away with not passing on the full amount of an interest rate reduction. Ritually of course, federal treasurers rail against such behaviour but it they are apparently unable to compel compliance. Is this to maintain the myth of independence?

    Best wishes

  2. I get into this question on other forums from time to time.

    Someone says the the US Fed. is owned by its member banks and pays them some money every year.

    I say to them —
    1] The US Gov. appoints all the governors of the Fed,
    2] All the profit of the Fed. is paid into the US treasury account.
    3] This profit is 97% of its revenues. Meaning the money paid to the “owners” must be less than 3% of its revenues and the other 97% is paid to the real owners, the US Gov.

    They say the Fed. is owned by its share holders, the member banks. And I’m wrong.

    They just can’t grok it.

  3. @Barri mundee
    not bill but basically banks make money by taking the spread between long term lending and short term borrowing. At low interest rates their margins get squeezed. Passing it on hurts their bottom line.

  4. It is more akin with the Roman Republican governors of Gaul or Roman governors of Brittania.

    Once they get their men into the governors house and treasury all they have to do after that is send a pigeon to Washington. Await on instruction from their emperor.

    Then fund red or blue to make sure they always win. Or create a false prophet in their own image like Macron.

  5. You might be being a little unfair to Dennis Healey. He was manipulated by the Treasury who supplied him with duff numbers. Healey later admitted in his autobiography that he had been conned. Hindsight can make all of look like fools but it was over 40 years ago and MMT was but a twinkle in your eye. Healey was chancellor to Callaghan who was probably influenced by his ‘genius’ of a son-in-law. Anyway, whatever Healey’s faults he was probably too left wing to be tolerated in the Labour Party today.

  6. Bill,

    I hope you have emphasised to your friend Yanis how unreformable the EU is.

    BTW, Mark Carney is nominally in post until 16th March this year. I don’t particularly object to “my” central bank being run by a Canadian (after all, they are old friends of ours, and he has taken out UK citizenship as well). However, I do rather object to it being run by an ex-Goldman Sachs employee.

  7. “However, I do rather object to it being run by an ex-Goldman Sachs employee”.

    But …isn’t everything? After all, we have Lloyd Blankfein’s word for it that they are doing God’s work and he should know, if anyone (apart from God of course) does.

  8. I may be wrong but I’m fairly sure I read somewhere that the autonomy of the Bundesbank is written-into the Bundesrepublik’s constitution, as are control over inflation as sole supreme policy-objective and the laughingly-named Stability and Growth Pact’s magic numbers governing maximum public debt, size of deficit etc. as percent of GDP.

    If so, then it must surely be literally correct to describe the Buba as independent from government *within Germany*. However, when it came to the Buba’s member (Isserling?) on the ECB’s governing council opposing the ECB breaking the Treaty rules on not bailing-out member-govts, Merkel was able in that extra-territorial context to over-rule him without breaching the BR’s constitution (whereupon he resigned – from the ECB council and (?) as head of the Buba too (?), can’t remember exactly).

    Given that Germany’s word is law, effectively, within the eurozone if not the whole EU it would hardly be surprising if the “German model” of CB independence was slavishly emulated everywhere else.

    And although knowing zero about the fine print of the EU battery of treaties, I’d be surprised if somewhere within that verbal death-trap there wasn’t some clause or other making CB “independence” mandatory for all EZ member-states.

  9. @ Rod White
    “You might be being a little unfair to Dennis Healey”.

    I would say, most definitely so and more than a little. Bill at every opportunity repeats the canard that Healey (and Callaghan) “lied”. I think that would be libelous if they weren’t both dead. You can only justly be found guilty of lying if you knew the truth beyond a peradventure *at the time* and knowingly stated the opposite. Historically, they didn’t. I don’t understand why Bill goes on traducing them in this way., especially seeing that they’re hardly in a position to defend themselves.

    If I were a family-member of theirs I’d be very upset.

  10. Dear Rod White and robertH (at 2020/03/03/7:09 am)

    Your defense of Healey is rather ahistorical and buys into the line that he and Callaghan were innocent victims of Treasury caprice.

    I know that is the line the Guardian has been running but is contrary to the facts of the time.

    1. Healey became an ardent Monetarist and actively worked to vilify the Bennite faction in the Labour Party. One can reasonably argue they made it much easier for Thatcher to emerge and also laid the foundations for the mess that the Party is in now. Callaghan and co ruined the Labour Party’s credibility at the time with their Monetarist nonsense.

    2. But moreover, whether Treasury was misleading them or not, the fact remains that Healey knew that he was not being truthful when he told the British people that the Government would have to borrow from the IMF because it did not have sufficient sterling.

    He knew that the Government was the ultimate issuer of sterling currency and also had the legislative capacity to do whatever they wanted in relation to the Bank of England.

    If you now claim he didn’t know that, then you are just acknowledging he was a charlatan who should never have accepted the appointment as Chancellor.

    Read the official documents – the Cabinet papers, etc of the day.

    He was looking for a way to save face with the Trade Unions while hacking into government spending and not doing enough to reduce unemployment.

    It is ridiculous to claim I am destroying his reputation. He did that himself.

    best wishes

  11. Dear Bill

    “I know that is the line the Guardian has been running…”

    Do I perhaps detect an insinuation that we are Guardian dupes – with all that that implies in this forum? (Personally I never read the Guardian) –

    “…but (it) is contrary to the facts of the time”

    In your opinion.

    I defer unhesitatingly to your mastery in your own field and wouldn’t dream of disputing with you about it. Here however we are debating not about MMT but history and politics. Those raise questions of interpretation, which will always be to some extent in dispute and over which scholars in those fields may go on arguing for many years to come.

    In my opinion your interpretation of what you deem to be “the facts of the time” is plain wrong.

    It amazes me that – while on the one hand both the principle exponents of MMT and us followers constantly bemoan the almost complete blindness of today’s politicians (as well as the entire body of mainstream economists) towards what the MMT lens could tell them if only they would discard everything they’ve been taught – on the other hand politicians of nearly half a century ago are arraigned (demonised almost) for not having had the perspicacity to have seen *their* world through the (then non-existent) MMT lens and formed their policies and actions accordingly and, moreover, are accused of having neglected to have done so in full knowledge that that was what they were doing – ie of having acted “with malice aforethought”, in effect.

    !975 was only four years after Nixon closed the gold window and two years after the Smithsonian agreement was made (yes, I know it failed too). For all practical purposes it was still a “gold-standard” world (come to that it still is today, to a significant extent, as we constantly sorrowfully acknowledge!). We with our hindsight may deplore how easily the politicians of the time were beguiled by Friedman but the historical fact is that they were – like it or not. The besetting obsessions of the time were the sterling balance of payments, defending the value of the £ (and the constant *perceived* risk of a run on it) and the size of the so-called PSBR (“public sector borrowing requirement”). (I employ the then current terminology deliberately, as a means to typify the completely different perspective which was then the only paradigm in town). There was absolutely no question then but that the country’s economy – “Great Britain Ltd” as it was dubbed – was no different from a household’s. One may in retrospect disapprove of some or all of their attitudes and prejudices, and criticise what we regard as misjudgments – but all such are matters of opinion. They don’t entitle us to accuse them of deliberately lying unless they can indisputably be proved to have done so.

    “Your defense of Healey is rather ahistorical and buys into the line that he and Callaghan were innocent victims of Treasury caprice”.

    “It is ridiculous to claim I am destroying his reputation. He did that himself.”

    Hindsight is a wonderful thing: it confers omniscience. The only snag is, it’s retrospective not contemporaneous omniscience. If I may presume to say so, of the two positions – yours, and Rod White’s and mine – it is yours which is in my opinion the more ahistorical and (hence) “ridiculous”. But obviously we’re never going to agree about that.

    best wishes

  12. Robert, sorry but I am with Bill on Healey. You are wrong when you say that monetarism was the only paradigm in town. It wasn’t, though it was the dominant one. When Healey said that the government had run out of money and had to go the IMF, I asked myself, why is that lying bastard lying to us, though not quite in that Paxmanian way.

    Not everyone agreed with me, but I had been influenced by the work of John Kenneth Galbraith whose emphasis was on using the economy for the public purpose, as he put it, and going to the IMF was not it. I was also influenced by knowing that the UK Treasury had fought with Keynes every step of the way, so I was, perhaps also influenced by Galbraith, not exactly entranced by the so-called Treasury view taken on board by Healey. So, I was already prepared to reject Healey’s position as fundamentally false when he announced it.

    Healey’s and Callaghan’s position did not strike me at the time, and does not strike me now, as being as historically inevitable as it seems to me you appear to be claiming it was. I contend that he could have done other than he did. That he didn’t has, I would argue, played a not insignificant role in influencing UK economic policy then and now to the detriment of all but the rich.

  13. “Healey’s and Callaghan’s position did not strike me at the time, and does not strike me now, as being as historically inevitable as it seems to me you appear to be claiming it was. I contend that he could have done other than he did.”

    I don’t claim it was inevitable that Healey and Callaghan did what they did; it seems to have been pretty convincingly shown *in retrospect* that an IMF loan wasn’t necessary. But in my opinion it has not been shown that anyone in government knew that at the time when the decision to apply for it was made, and therefore that to accuse anyone of lying is justifiable.

    Unlike you, I can’t claim to have had enough insight to question the rightness of Healey’s judgment at the time: as far as I can now remember I guess I just accepted that he must know what he was talking about. But even you from your clearly better-informed position than mine are not claiming to have *known* that the Treasury was leading the Chancellor up the garden path – your suspicions were much vaguer than that.

    Benn with his “alternative economic strategy” was in a minority of one in the Wilson cabinet when the decision to go to the IMF was taken, and no one else in that cabinet could see any other alternative. The idea that Healey might lie to them never so much as crossed any of their minds, and they were not credulous fools.

    To have been shown afterwards to have been panicked on the basis of bad forecasts into making a serious mistake is one thing; to be accused of having out of machiavellian motives knowingly lied about the true facts is another thing altogether.

    I suspect that Bill’s imputation that Healey had become predisposed (by monetarist doctrine) to be unduly influenced by Treasury officials’ pressure to go to the IMF is probably right. That doesn’t make him a liar.

  14. 6 billion euros, that’s beyond ridiculous. And, yet, I’m starting to think it won’t go away in the GFC v2.

  15. Rather than pushing against this, we should roll with it. “Independent” central banks are run by unelected technocratic wonks with policy discretion. That adds an unacceptable, and unelected, human dimension to the operations of the central bank. They get it wrong, time and again. They are susceptible to influence and groupthink.

    What we need to do is *upgrade* the central banks from independent to autonomous – running solely the automatic fiscal stabilisers and ensuring that banks lend within acceptable criteria and automatically putting them into administration if they don’t. The wonks then just process the paperwork according to legislative policy. No discretion for the bank, or the government.

    Autonomous > Independent.

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