Central banks were not very popular in mid-2016. In years past, the Federal Reserve and its contemporary banks remained in the background of public discourse. Debate about central bank activity was contained to academic white papers and peer-reviewed journals. Those days have given way to an ever-increasing number of vocal central bank critics, ranging from high-profile politicians to leading financial experts, who question the bank’s policies and oft-touted independence.
Critics of Central Banks
Consider the May 2016 thought leadership piece by PIMCO Global Economic Advisor Joachim Fels, “The Downside of Central Bank Independence,” which argued that independent 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. Also, examine the March 2016 proposal by Joseph T. Salerno, professor of economics at Pace University in New York, called “A Modest Proposal to End Fed Independence.” Salerno pointed out “a number of benefits of stripping the Fed of its quasi-independent status and transforming it into a handmaiden of the Treasury.”
Why Central Banks Are Independent
Historically, governments do not responsibly handle the duty of conducting monetary policy. The most infamous modern cases, Argentina, Hungary, Zimbabwe and pre-WWII Germany, ended in brutal hyperinflation. This is because it is tempting for governments to explode beyond their own budget constraints or for politicians to enrich themselves at the expense of their citizens' purchasing power. In short, the Fed theoretically needs independence to make neutral, politics-free monetary policy decisions without direct political pressures.
For these reasons and several more, most serious policy analysts of the 20th century considered independence a prerequisite for any effective central bank. Calls for reform have only come after the recent and disastrous failures of contemporary central banks, especially the big three: The Federal Reserve, European Central Bank (ECB) and Bank of Japan (BOJ).
Failures of Central Banking
The Fed has had difficulty on two fronts. First there was the massive data leak by Goldman Sachs Group (NYSE: GS). Former managing director Joseph Jiampietro allegedly obtained and shared confidential Fed information to win new contracts, a move that eventually forced Goldman to pay $36.3 million in a settlement. This episode followed a $50 million settlement in October 2015 when a different Goldman employee obtained 35 confidential Fed documents.
The second issue is performance. As 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 left the world with unprecedented debt loads, over-inflated asset markets and rising inequality. The great concern of unchecked government control over the money supply, namely unchecked expansion based on economically dubious experiments, is now official policy for independent central banks.
Calls for Reform
The loudest critics of Fed independence have been House Republicans, particularly those on the Financial Services Committee. In February 2015, Committee Chair Jeb Hensarling (R – TX) opened a hearing by telling Fed Chairwoman Janet Yellen he doubted the Fed’s efficacy and excoriated the central bank for a lack of transparency and accountability. “Fed reform is coming,” Hensarling told Yellen. In July 2016, the Republican party announced that its platform for the 2016 elections will include “advance legislation that brings transparency and accountability to the Federal Reserve.”
Yellen, as with former Chairman Ben Bernanke, has maintained a public profile during her tenure in an effort to appear more transparent. She regularly meets with the White House and Congress, and often gives policy speeches and holds press conferences to highlight Fed activity.
What a New Central Bank Could Look Like
Opinions are shifting quickly. As recently as April 2014, the International Monetary Fund (IMF) held a conference on “Rethinking Macro Policy,” from which the general consensus was “central banks should retain full independence with respect to traditional monetary policy.” By August 2015, the World Economic Forum openly questioned central bank independence and argued that policymakers should go beyond the taboo of coordinating fiscal and monetary policies.
Dr. Salerno recommends a more transparent and limited process controlled by administrative orders between treasury departments and central banks, stealing away the moral hazard of the lender of last resort and ridding central banks of their coordination with huge financial corporations. Voters would exercise much greater control over the political fortunes of such a process. Mr. Fels shares similar sentiments, contending that it would make more sense if central banks worked in close collaboration with governments and under the control of the democratic process.