The Cycle of Central Bank Independence

What a difference a crisis makes. In 2006, the central bank world was one of calm consensus, with widespread agreement on the role of central banking and the place of the institutions themselves in society.  Central banks were technical experts, charged with delivering price stability and granted widespread independence of operation as they used their technical skills and market presence to achieve it. Furthermore, since the goal was largely non-controversial and supported by all sides of the political spectrum, central banks were broadly successful in establishing a consensus that they should be independent of politicians as they pursued it.  In short, and despite some residual concerns over the democratic deficit of public servants operating under only the lightest of political oversight, both politicians and central bankers themselves did their utmost to “depoliticise” the central bank.

This is no longer the case. As a result of the crisis, many governments have taken a much more direct and interventionist role in their economy and financial system, and inevitably some of this is politically controversial.  And as the main agent of government in the markets, the central bank cannot avoid this controversy entirely.  In short, central banks have been thrust back into the political debate, and are no longer in a comfortable non-political and technical space.

For the historian, it is hard to escape a feeling of déjà-vu. The recent independence of central banks is but nothing compared to the independence enjoyed by their predecessors in the 1920s.  Then, the major central banks really were independent – their leaders such as Montagu Norman, Governor of the Bank of England, and his opposite numbers Moreau at the Banque de France, Strong at the New York Federal Reserve and Schacht at the Reichsbank negotiated directly with each other and without consulting their finance ministries, or even in some cases informing them of agreements reached.

Such independence and power is unthinkable now, and became unacceptable even then after the financial world collapsed in 1929-1933. Governments had to step in to restore order and solvency to the financial system, and having done so, systematically trimmed the bankers’ wings:  the New York Fed was placed more firmly under the Board of Governors, and both the Bank of England and the Banque de France were nationalised within 15 years.

It seems that central bank independence is not a monotonic progression but a swinging pendulum, as central bankers oscillate between close political oversight and relative operational freedom. Right now the pendulum is swinging back to the politicians – but we have been here before, and no doubt in 50 years time a cry will go up to free the central bankers again from political meddling.  For our grandchildren’s sake, one hopes that the third time round, independent central banks will be more successful in avoiding a repeat of the crashes of 1933 and 2008.