NCPA - National Center for Policy Analysis

Central Banks Losing Autonomy

March 14, 2013

Central banks, which manage a country's currency, money supply and interest rates, are important policy tools in managing the economy. Central banks around the world took drastic actions to reduce the impact of the global financial crisis that struck in 2008. Economic output has been resilient throughout the crisis, but central bank independence has suffered, says Sylvester Eijffinger, a professor of financial economics at Tilburg University, and Edin Mujagic, a monetary economist at Tilburg University.

  • During the 1970s, when the world was confronted by recession and rising inflation, the independence of Germany's Bundesbank, which had great success in lowering inflation, triggered countries around the world to increase central bank independence.
  • After inflation fell, lower-than-expected outlays and higher-than-expected income for Western governments meant that central banks did not need to print money.
  • Following 2008, printing money has been an easy alternative to large tax increases or drastic reductions in government spending.

As a result, fiscal policy, which relates to government revenue and spending, has trumped monetary policy. Increasingly, central banks are bowing to political pressure.

  • The Bank of Japan has shed its autonomy by recently agreeing to buy an unlimited number of government bonds to meet its 2 percent inflation target.
  • Similarly, the Bank of England has continually loosened monetary policy and is buying almost every new British government bond that is issued.
  • Likewise, the U.S. Federal Reserve is buying more than 90 percent of newly issued U.S. Treasury securities.

Central banks are essentially financing government spending. And though they once had an air of independence, an examination of each central bank's governing status reveals that each bank is undeniably linked with the government's economic policy positions.

Though the European Central Bank (ECB) does not suffer from the same codified relationship with its host countries, it has acted less and less independent through the recent financial turmoil. Increasingly, the ECB, which operates by allowing each member country a vote on policy, is opting to purchase large quantities of government bonds from struggling periphery countries.

Independent banks are becoming more centralized and responsive to the desires of politicians. Increasing inflation may indicate that the long-term price stability once provided by independent central banks may give way to continued high inflation.

Source: Sylvester Eijffinger and Edin Mujagic, "Independence Lost," Project Syndicate, March 6, 2013.


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