Central bank independence — institutionalizing monetary handcuffs

from Lars Syll

Imposing a hard target can bind the central bank, but the government must then act on failures to hit the target. Why would it if it is self-interested? If it does, that amounts to saying it is not selfish, which undermines the argument that independence is needed. The same argument can be used to deconstruct independence itself. Suppose independence is a solution to time inconsistency. Why would a selfish politician ever agree to independence in the first place? If they did, that would be tantamount to saying they are not selfish, in which case independence is not needed. In other words, only non-self-interested politicians choose independence, making independence redundant …

Even if the banker is honest, there still remains the fundamental question of why would selfish politicians go against their own interests and appoint a conservative independent central banker? Doing so is tantamount to proving they are not selfish, in which case there is no need for an independent central bank. That microeconomic contradiction suggests something else is going on with the shift to central bank independence. By definition, selfish politicians cannot be authorizing it out of public interest. Instead, they are doing so out of self-interest, which is the clue to understanding the real reasons for the shift to central bank independence … That implies central bank independence is not the socially benevolent phenomenon mainstream economists and central bankers claim it to be. Instead, somewhat obviously, it is a highly political development serving partisan interests …

The real issues are why do independent banks go after inflation harder, and what is the role of independence?

The reason they go after inflation harder is they are aligned with capital. That is because capital is politically in charge and sets the goals for central banks. It is also because central bankers and their economic advisers have bought into the Chicago School monetary policy framework which implicitly sides with capital (i.e. views the problem as being inflation prone government). That explains why there is central bank independence …

Democratic countries may still decide to implement central bank independence, but that decision is a political one with non-neutral economic and political consequences. It is a grave misrepresentation to claim independence solves a fundamental public interest economic problem, and economists make themselves accomplices by claiming it does.

Thomas Palley