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Is central bank independence under threat?

Some 22 years ago UK chancellor of the exchequer Gordon Brown took the surprise decision to give the Bank of England operational independence to set monetary policy. The setting up of the Monetary Policy Committee (MPC), has had the independence to set interest rate policy and target inflation, independent of fiscal policy, which was left in the hands of politicians.

The rationale for doing this was clear in that it would take the day to day setting of interest rates out of the hands of politicians and introduce a level of stability into the realms of economic policy, where politicians were able to move interest rates on a whim.

By and large it has worked well with inflation never having moved much beyond the 5% level here in the UK apart from a brief period in the aftermath of the financial crisis.

The after effects of the financial crisis have placed this independence under strain, not only here in the UK, but in the wider world as well, with central bank officials in the US, the EU and Japan, coming under fire from politicians who really ought to know better, and implement the reforms necessary to complement central bank policy.

In the US Federal Reserve chairman Jerome Powell has come under fire from President Trump for raising interest rates too quickly against a backdrop of a US economy that outperformed all of its peers in 2018. It seems Trump wasn’t so reticent when Obama was President, criticising the Fed for keeping rates too low.

Quite rightly the now President Trump has been heavily criticised for interfering in the Feds monetary remit, and trying to politicise it, as he should be. His threats to fire, and or demote Jay Powell and interfere with monetary policy, are a significant threat not only to the Feds independence, but financial stability in general.

President Erdogan of Turkey has also come under fire for usurping the power of the Turkish central bank by installing his brother in law, because central bank officials won’t do his bidding.

Here in the UK, Bank of England governor Mark Carney has more often than not courted controversy for some of his decisions as central bank chief, but whatever the criticisms he is still one vote out of nine and as such can be outvoted if necessary, and while he had been accused of being political, he is still well qualified for the role.

In Europe the European Central Bank has also come under fire for being too political during the term of ECB President Mario Draghi. On a number of occasions it has been accused of overstepping its boundaries in the case of Greece, Ireland and Italy, during the recent Eurozone debt crisis when it threatened to cut off liquidity to their banking systems unless politicians did the EU’s bidding.

Despite these concerns there were still limits to what ECB was able to do with a persistent refrain of Mario Draghi that politicians needed to do more when it came to structural reforms to make the euro more stable.

Having also been given oversight of European banks and financial stability the ECB’s role is likely to become even more important, with questions already being asked about its actions and motivations over the Monte de Paschi bailout, which appeared to break its own rules.

This is why the recent announcement of the nomination of Christine Lagarde as the next President of the European Central Bank is so concerning, when it comes to the perception of the central banks independence.

Formally a French finance minister and currently in charge of the IMF she is a lawyer by training, and a politician to boot. Her experience as head of the IMF is mixed at best, with her role in the Greek bailout heavily criticised where the IMF broke its own rules on debt sustainability.

Furthermore her deputy is also an ex-politician Luis De Guindos, who as finance minister of Spain had to be dragged kicking and screaming to accept a bailout for the Spanish banking system. He does at least have a background in economics, and has worked in financial services, but he isn’t a central banker.

There is also the rather inconvenient fact that Christine Lagarde has a conviction for negligence from a French court in respect of her time as French finance minister.

Whatever her qualities as a politician, and a negotiator, both of which are considerable, they cannot prepare her for the role of what is unarguably one of the most important central banks in the world, an institution that not only sets monetary policy, but also regulates its banks and the financial system across Europe.

In any other role her CV wouldn’t pass muster, which makes this appointment all the more political. While one can understand it given the problems the euro area faces, it’s a dangerous look when it comes to credibility. It’s like putting someone with a standard car driving licence in charge of an HGV.

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