Should Central Banks Be Independent?

Historically speaking, the U.S. Federal Reserve and central banks of other nations have enacted irresponsible and counter-efficient monetary policies. After all, policymakers are ever-tempted to line their own pockets at the expense of their citizens' purchasing power. This has led to brutal hyperinflation in countries like Argentina, Hungary, Zimbabwe, and pre-WWII Germany. In most such cases, governments outspend their own budget constraints.

Key Takeaways

  • The United States Federal Reserve and other central banks of the world have historically exhibited abysmal track records of creating responsible monetary policy.
  • Poor central banking policies ultimately lead to governments outspending their own budget constraints.
  • Irresponsible monetary policies diminish purchasing power, which often causes crippling hyperinflation, as had famously occurred in countries like Argentina, Hungary, Zimbabwe, and pre-WWII Germany.
  • There has been a recent push to reform monetary banking policy, so that it widely reflects greater transparency and independence.

Critics of Central Banks

In years past, ill-advised central banking activities slid by largely unnoticed. But recently, everyone from politicians to financial experts have been vocalizing their disapproval of questionable central bank policy decisions and practices.

In a May 2016 white paper entitled “The Downside of Central Bank Independence,” PIMCO Global Economic Advisor Joachim Fels argued that central bankers ran amok with "second-best interventions such as quantitative easing (QE) or negative interest rate policy (NIRP), which distort financial markets and can have severe distributive consequences."

Why Central Banks Should Be Independent

Central banks have largely failed to design neutral monetary policies, without direct political pressures unduly influencing their decisions. The most egregious trio of offenders, known as the Big Three contemporary central banks, are the Federal Reserve, European Central Bank (ECB), and Bank of Japan (BOJ). In light of their trespasses, modern analysts have called for broad central banking reform, where independence is of paramount importance for any effective central bank policy.

Failures of Central Banking

The Fed has experienced difficulty on two fronts. First, there was a massive data leak by Goldman Sachs Group (NYSE: GS), where former managing director Joseph Jiampietro allegedly obtained and shared confidential Fed information in a concerted effort to win new contracts. This move, which ultimately forced Goldman to pay a $36.3 million settlement, followed a $50 million settlement in October 2015, when a separate Goldman employee obtained 35 confidential Fed documents.

The second main issue related to inferior performance. As economist Mohamed El-Erian wrote for Bloomberg in June 2016: "Unconventional central bank policies are overstretched and near exhaustion."

More than a half-decade of desperate asset purchases and interest rate reductions by central banks has ultimately saddled nations with unprecedented debt, over-inflated asset markets, and rising inequality.

What a New Central Bank Could Look Like

In April 2015, the International Monetary Fund (IMF) held the third iteration of a conference entitled “Rethinking Macro Policy.” The general consensus found that central banks should retain full independence with respect to traditional monetary policy.

Pace University economics professor Joseph T. Salerno recommends a more transparent and limited process controlled by administrative orders between treasury departments and central banks. This should discourage the moral hazard of the lender of last resort and eliminate central banks' ties to large financial corporations, while empowering voters to exercise greater control over the political fortunes of such a process. Mr. Fels concurs, contending that it's logical for central banks to collaborate with governments, under the control of the democratic process.

During their respective tenures, former Fed Chair Janet Yellen and former chair Ben Bernanke both maintained public profiles, in an effort to appear more transparent than previous Fed leaders.

Article Sources
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  1. Harvard University. "Central Bank Independence Revisited: After the Financial Crisis, What Should a Model Central Bank Look Like?" Page 2.

  2. PIMCO. "The Downside of Central Bank Independence."

  3. International Monetary Fund. "Transparency Makes Central Banks More Effective and Trusted."

  4. New York State. "Press Release October 28, 2015."

  5. U.S. Federal Reserve Board. "Federal Reserve Board Orders Goldman Sachs Group to Pay $36.3 Million Civil Money Penalty and Announces It Is Instituting Enforcement Proceedings Against Former Goldman Sachs Managing Director."

  6. Bloomberg. "As Central Banks Meet, Japan's Faces the Toughest Dilemma."

  7. American Institute for Economic Research. "Central Banks Contribute to Inequality."

  8. House Committee on the Budget. "Reexamining the Costs of Debt in an Era of Low Interest Rates."

  9. International Monetary Fund. "Ten Take Aways from the 'Rethinking Macro Policy: Progress or Confusion?'"

  10. Mises Institute. "A Modest Proposal to End Fed Independence."

  11. Federal Reserve History. "Ben S. Bernanke."

  12. U.S. Federal Reserve Board. "Remarks Accepting the 2017 Paul H. Douglas Award for Ethics in Government."