2024-09-17 14:57:47
This is a recurring topic of debate in economic theory: while for some, the independence of central banks would be harmful to growth. Others believe, on the contrary, that this independence guarantees against the risk of politicization of the currency, dangerous for the economy. A look back at a history spanning several centuries of burning topicality, particularly within the European Union.
As the ECB very cautiously lowers its rates, many voices are demanding a takeover central banks by politicians.
Independence in danger?
Table of Contents
- 1 Independence in danger?
- 2 A legacy of inflationary crises
- 3 Price stability mission
- 4 Reporting to the people’s elected representatives
- 5 The Age of Secrecy
- 6 Expansion of the central bank’s domain
- 7 New debates
- 8 Two toxic challenges
- 9 Collective amnesia
- 10 How does the independence of central banks contribute to economic stability?
It is probably excessive to affirm, with the American comedian, Will Rogers that there have only been three great inventions since the beginning of time: fire, the wheel and the central bank. Nevertheless, they play – even more today than in his time – a crucial role in developed economies. If the central bank of sweden Founded in 1668, it claims the title of the oldest central bank in the world, as the first to issue banknotes. For a long time, the monetary institution par excellence was the old lady of Threadneedle Street: The Bank of England founded in 1694.
With the legal privilege of issuing currency and playing the role of bank of banks as lender of last resort in the event of a financial crisis, the European central banks have perfectly fulfilled their cardinal mission throughout the 19th century.e : the stability of the currency, since the word inflation only had a medical meaning until the Great War, as the Littre.
A legacy of inflationary crises
At the same time, Americans had been living without a central bank since 1837, President Andrew Jackson having abolished it in the name of freedom of enterprise and a distrust of a centralized institution. Americans therefore lived to the rhythm of the bank runs and bank failures in the United States. It was not until the serious financial and banking crisis of 1907 that Congress decided to institute the Federal Reserve in 1913.
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Since then, central banking has continued to gain independence and power in developed countries under pressure from citizens concerned about their purchasing power and wary of a political class always ready to sacrifice the stability of the currency to its electoral calendar. Emblematic of this trend, the German central bank created in 1948 to ward off the specter of hyperinflation in 1923 and the end of the Second World War, was the first to have its independence legally recognized in 1951. It made the deutschmark the paragon of strong currency until its absorption by the euro in 1999.
Price stability mission
Elsewhere, it was more the memory of the inflation of the 1970s which led to the formal independence of the Bank of France in 1994 and then of the Bank of England en 1997In rich countries, the central bank’s mission has thus clearly focused on price stability, with the objective of a target inflation rate of 2% gradually becoming the norm not to be exceeded, although support for growth is also explicitly mentioned. Gradually, a ordoliberal theoretical framework based on freedom of enterprise and private property, but regulated by institutions. Monetary policy has then become a sophisticated technique that is no longer based on the intuition of a all-powerful governor but on rules like Taylor’s which links the interest rate to expected and observed inflation and to the output gap. Recently, these strict rules have been transformed into more flexible principles.
Reporting to the people’s elected representatives
Today, the independence of central banks is both legal, institutional and instrumental since they define their own objective and monetary policy. There is also a personal dimension to this independence of their leaders, appointed by elected officials for their pragmatism, experience and competence, with a long irrevocable mandate. Finally, independence is budgetarily ensured: they do not depend financially on States, but on the contrary pay them regular dividends.
The considerable power they hold through their position at the top of the monetary order of their zone is not, however, without demanding counterparts. Thus, they have the obligation to account for their actions before the representatives of the nations whose currency they manage. This is why their leaders are regularly heard before elected officials, the Congress in the United States or the European Parliament but always with the prohibition of receiving or requesting any instruction from the public authorities.
The Age of Secrecy
Although central banks have gained their independence and mastered their strategy and tools over time, they are still criticized for the low transparency of their public communication. The era of secrecy is certainly over, but the question of the disclosure of the minutes of their deliberations remains unresolved, with the ECB publishing only an excerpt of its meetings. 4 weeks laterthe Fed 3 weeks later which allows observers to understand the evolution of their analyses according to the economic situation.
Faced with the two major systemic crises of the beginning of the 21st century,ethat of the “subprimes” of 2008 and of the Covid of 2020, the central banks had to completely revise a centuries-old doctrine after having lowered their rates in an unprecedented manner zero key rate.
Expansion of the central bank’s domain
To avoid two major global depressions, they issued massive amounts of money and multiplied the size of their balance sheet. Moreover, legislators aware of the risks of future large-scale banking crises have entrusted them with the supervision of large banks. Thus, in 2014, EU members granted the ECB supervision of the 130 largest European banks, known as systemic banks (which risked undermining the financial stability of the zone in the event of a financial difficulties or even bankruptcies of these).
If Europe has avoided American bankruptcies such as that of Silicon Valley Bank after a relaxation of their regulation under Donald Trump’s mandate or at our neighbors Credit Suisse, this regulatory movement is clearly not successful. The Archegos and FTX cases reminded us that the « shadow banking »which represents about half of global financial assets, or 218,000 billion dollars (and whose growth is also one of the consequences of increased control of the banking system), remains a black hole of regulation.
New debates
Moreover, to strengthen the stability of the financial system, banks, particularly French ones, are pleading pro domofor a better profitability of the banking sectorThe development of new technologies and blockchain has also led monetary institutions to study the implementation of a digital currency, a digital euro in Europe, which would constitute a free, simple, universally accepted means of payment issued directly by a bank that cannot go bankrupt.
Finally, the speed of climate change has led central banks to integrate decarbonization into their monetary policy as early as 2020. This is how the ECB is starting to distinguish between green and brown assets in the guarantees required for its loans to banks. It is also seeking to direct investments towards those that promote the energy transition.
Two toxic challenges
Central banks have always been the subject of criticism from the political class, but their accusations have been exacerbated by the resumption of inflation in 2020 and the sharp increase in interest rates around the world.
In the United States, the Fed chairman is being strongly attacked by Donald Trump, whom he had appointed in 2017, because he allegedly favors the Democrats. Incidentally, he claims that his success in business is proof that his instinct is often better than the analysis of the Board of Governors…
In April 2024, Emmanuel Macron considered that the ECB’s mandate focused on inflation was now obsolete and that it was necessary to add a growth objective or even a decabornation objective which, however, already exist… All these controversies led the IMF director to publish studies proving the rationale for monetary policies carried out over the past few decades.
But the most dangerous attacks on the euro come from supporters of the pure and simple cancellation of public debts held by the ECB (in 2024 more than 25% of the outstanding government bonds of member countries) on the grounds that Europe must take back control of one’s destinyThe Union Treaty prohibits the monetization of public debt and therefore a fortiori their cancellation, but the ECB had explained that purchases of government bonds were exceptional at the time of the 2020 crisis and carried out not at issue but on the secondary market.
Collective amnesia
While the lessons of the hyperinflation episodes of the interwar period and the inflation of the 1970s are gradually fading, the more recent ruin of the Lebanesethe fall in purchasing power suffered by the Turkish middle classes and in Europe, the Hungarian prices soar which hits the poorest hard, should make the most populist politicians think again. This is why independent central banks focused on inflation are today, as yesterday, the necessary, although not sufficient, conditions for maintaining household living standards.
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How does the independence of central banks contribute to economic stability?
The Independence of Central Banks: A Delicate Balance between Economic Stability and Politicization
The independence of central banks has been a topic of debate among economists and policymakers for centuries. While some argue that it is essential for maintaining economic stability, others believe that it poses a risk of politicization. As the European Central Bank (ECB) cautiously lowers its interest rates, the debate has resurfaced, with many voices calling for a takeover of central banks by politicians.
A Brief History of Central Banks
Central banks have played a crucial role in developed economies since the 17th century. The Bank of Sweden, founded in 1668, is considered the oldest central bank in the world. The Bank of England, established in 1694, was the monetary institution par excellence for a long time. Throughout the 19th century, European central banks successfully fulfilled their primary mission: maintaining the stability of the currency.
A Legacy of Inflationary Crises
However, the United States had a different experience. Without a central bank since 1837, Americans lived through bank runs and bank failures. It wasn’t until the 1907 financial crisis that Congress established the Federal Reserve in 1913. Since then, central banking has continued to gain independence and power in developed countries, driven by citizens’ concerns about purchasing power and the risk of politicization.
Price Stability Mission
Today, central banks’ primary mission is to maintain price stability, with a target inflation rate of 2% becoming the norm. Although support for growth is also explicitly mentioned, monetary policy has become a sophisticated technique based on rules rather than discretion. The theoretical framework of ordoliberalism, which emphasizes freedom of enterprise and private property, has shaped central banks’ decision-making.
Reporting to Elected Representatives
While central banks enjoy a high degree of independence, they are not immune to accountability. Their leaders are appointed by elected officials and must report their actions to them regularly. This oversight ensures that central banks remain transparent and accountable
