What Has Central Bank Independence Ever Done for Us?
Speech given by
Andy Haldane
Chief Economist and Member of the Monetary Policy Committee
UCL Economists' Society Economics Conference
28 November 2020
The views expressed here are not necessarily those of the Bank of England or the
Monetary Policy Committee. I would like to thank Oliver Bush, Richard Harrison,
Derrick Kanngiesser, Jack Meaning, Michael Salib, Caroline Sijbrandij and Rhiannon Sowerbutts for
their help in preparing the text. I would like to thank Andrew Bailey, Ben Broadbent, Oliver Dearie,
Nick Mclaren, Silvana Tenreyro, Tom Smith and Gertjan Vlieghe for their comments.
1
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I am delighted to be giving this talk at the UCL Economists' Society conference (even though it is on a
Saturday). Many congratulations to the organisers for assembling such an excellent array of speakers from
around the world. I want to discuss a topic close to my own heart - central bank independence.
In many respects, central banking came of age in the 20th century. At its start, the world had only 18 central
banks (Chart 1). Most did not have a well-defined statutory, much less independent, role in setting monetary
and financial stability policies. They operated, by and large, as an operational agent of government.
Chart 1: Number of central banks
Number of central banks
Number of independent states
Number of independent central banks
200
ECB
150
100
50
Bank
of Japan
Banque
US Federal
Sveriges Bank of
de France
Reserve
Riksbank England
0
1668 1718 1768 1818 1868 1918 1968 2018
Source: Central Banking Directory
By the end of the 20th century, the world had around 200 central banks, pretty much one for each nation
state. The fraction of them with operational independence for the setting of policy had risen to 80-90%
(Chart 2). Central banks and their independence had become an international norm in the space of a
century.
Three years ago, the Bank of England hosted an event to mark the 20th anniversary of the
Monetary Policy Committee (MPC) and operational independence in the setting of monetary policy in the
UK.1 The most notable, and for me surprising, feature of that event was the number of speakers who said
they thought "peak" central bank independence had been reached.2
1
See https://www.bankofengland.co.uk/events/2017/september/20-years-on
2
For example, Balls et al (2018).
2
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Chart 2: Percentage of independent central banks
Monetary policy objectives All aspects 100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Source: Garriga (2016) using index of Cukierman et al (1992).
Notes: Central banks with values greater or equal to 0.4 on the index are defined as independent. 'Monetary policy objectives'
measures whether the central bank's objective is price stability. 'All aspects' includes variables related to the appointment of
the CEO/Governor, policy formulation; and limitations on lending to the government
The reasons for this included central banks' rising role in dealing with financial stability issues in the light of
the Global Financial Crisis; the rising populist geo-political tide; and, perhaps most significantly, the
increased purchases of government securities by central banks, so-called Quantitative Easing (QE). At the
time, global QE stood at around $11trillion, and global central bank balance sheets were around 55-65% of
global GDP, their highest levels in at least a century
(Chart 3).
This year has seen central bank balance sheets expand further. Global QE now stands at around $17 trillion
and is set to rise further. For some, this has blurred the distinction between monetary and fiscal policies to
an even greater extent than in the past. It has also intensified the debates and concerns around central
bank independence expressed at the Bank's conference three years ago.
Against that background, now is an opportune moment to ask some questions, and assemble some
evidence, on the case for central bank independence. How has it affected monetary and financial stability?
What challenges does it face at present? And how might it evolve in future?
Those are the aims of this lecture. I start with some definitions of central bank independence, which is a
multi-faceted and often misunderstood concept. I then discuss some of the theory and evidence on the role
of central bank independence in supporting monetary and financial stability, as well as its links with fiscal
policy. I will conclude with brief thoughts on central bank independence looking forward.
3
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Chart 3: Central bank balance sheets relative to GDP
Central bank balance
0.8
sheet/NGDP
0.7
Mean Median
0.6
0.5
0.4
0.3
0.2
0.1
0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Source: Data from Ferguson, Kornejew, Schmelzing and Schularick (2020). I am grateful to the authors for sharing this data with
me. Bank calculations.
Notes: Countries included are: Canada, France, Germany, Italy, Japan, the Netherlands, Norway, Portugal, Spain, Switzerland ,
the United Kingdom and the United States.
As a central banker, you might expect me to extoll the virtues of central bank independence. Spoiler alert, I
will not disappoint. As best evidence can tell, central bank independence has delivered "twin-wins" for price
and financial stability: low inflation and stable banks at no cost to the economy's output or efficiency.
Equally, this is a challenging time for the economy and for central banks. They will need to adapt to these
new challenges to boost public understanding of, and maintain democratic legitimacy in, central banks.
The Definition of Central Bank Independence
Independence is very rarely absolute or binary in any domain of public policy. It is almost always subject to
constraints on actions ex-ante and accountability mechanisms for those actions ex-post. Most forms of
delegated decision-making in democracies are accompanied by checks and balances.
Central bank independence is no exception. In no country in the world is it absolute, typically being subject
to multiple ex-ante constraints and ex-post accountabilities. The precise mix of these constraints and
accountabilities means there are many different degrees, dimensions and models of central bank
independence.
4
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As a legal matter, independence can be framed in terms of "four pillars":3
a) Quasi-constitutional independence;
b) Institutional independence;
c) Personal independence; and
d) Financial and economic independence.
Taking each in turn, the legally-strongest form of independence arises when there is a quasi-constitutional
declaration of central bank independence, for example through a Treaty. That is the case in the
European Union where the Treaty on the Functioning of the European Union provides that the
European Central Bank (ECB) "shall be independent in the exercise of its powers". Significantly, this
independence extends to the national central banks of the EU, meaning no individual EU Member State can
unilaterally amend or repeal independence.
With no codified constitution, there is no constitutional provision safeguarding the Bank of England from
political interference. The Bank's independence can be repealed by ordinary legislation. However, as
former Chancellor Nigel Lawson observed "the mere announcement of the intention to do so would in itself
4
be so damaging to market confidence that any Government would be extremely reluctant to attempt it."
This illustrates that wider (political, market and social) considerations are crucial for determining the
de facto
degree of independence, whatever the position.
de jure
Institutional independence arises from the legal remits and safeguards granted to central banks to carry out
their tasks, without fear of interference or instruction from the executive branch of government. There are a
range of institutional models of independence. One important design dimension is, in the language of
Debelle and Fischer (1994), the distinction between and independence.
target instrument
In the UK, the objectives of the Bank's three policy committees (the Monetary Policy Committee (MPC),
Financial Policy Committee (FPC) and Prudential Regulation Committee (PRC)) are defined in primary
legislation and set by Parliament. In other words, the Bank is This again differs
target-dependent.
elsewhere - for example, in the euro-area where the ECB is UK legislation also requires
target-independent.
HM Treasury to elaborate on these objectives periodically.
The Bank operates with operational independence over its tools to meet its statutorily-set objectives. In
other words, the Bank is for monetary policy and financial stability tools. Even these
instrument-independent
powers are, however, constrained. HMT has a set of statutory powers of direction over Bank decisions
which constrain its institutional independence in pre-specified, exceptional, circumstances.5 And the Bank is
3
Lastra (2015).
4
Lawson (1992).
5
Salib and Skinner (2019).
5
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subject to a wide range of statutory accountability devices, including publishing formal minutes and reports
and regularly appearing before Parliament.
A third dimension is independence - the appointment procedures and legal protections given to
personal
individuals assuming decision-making responsibilities. The Bank of England Act 1998 provides for a range
of protections in relation to qualification for appointment, remuneration and security of tenure. Subject to
these, most appointments to the Bank's statutory policy committees are made by HM Treasury, with
parliamentary oversight through the Treasury Committee.
The final legal pillar of independence is and Even if a central bank has
financial economic independence.
the other three protections, its independence could still be compromised if it had insufficient resources to
achieve its mandate (financial independence) or could be pressured to engage in monetary financing of the
government (economic independence).
For its financing, the Bank has legal powers to levy industry to recover the costs of its supervisory functions.
Supervisory levies are set annually after public consultation. The Bank finances its monetary policy and
financial stability operations through a Cash Ratio Deposit (CRD) Scheme which was placed on a statutory
footing by the Bank of England Act 1998. The terms of the CRD Scheme are set by HM Treasury through a
statutory instrument at least every five years after a public consultation process.
Protection of the Bank's economic independence is provided by the "prohibition on monetary financing",
encapsulated in Article 123 of the Treaty on the Functioning of the European Union. Some have questioned
whether the expansion of central bank balance sheets through QE constitutes a breach of the prohibition on
monetary financing. For example, the German Constitutional Court recently considered whether the ECB's
Public Sector Purchase Programme (PSPP) was in breach, concluding it was not. Nonetheless, some
commentators continue to associate QE with monetary financing, a point to which I shall return.
The multiple dimensions of independence mean a wide spectrum of central bank independence models
operate in practice internationally. This is clear from central bank legal statutes and from analysis of their
different practices. A cottage industry has emerged among academics to construct indices of central bank
independence, weighting together different of these dimensions of independence.6
Table 1 uses the indices of or legal, independence index recently constructed by Garriga (2016) for
de jure,
some of the OECD countries. This illustrates the spectrum of independence models that exist internationally.
It also demonstrates that central bank independence is, in every case, partial. Along the international
spectrum of central bank independence models, the Bank of England occupies an upper-quartile position.
6
See for example, Cukierman et al (1992).
6
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Table 1: measures of Central Bank Independence
De jure
Country CBI Measure
Australia 0.25
Austria 0.86
Belgium 0.86
Canada 0.47
Denmark 0.50
Finland 0.86
France 0.86
Germany 0.86
Italy 0.86
Japan 0.44
The Netherlands 0.86
New Zealand 0.35
Norway 0.45
Spain 0.86
Sweden 0.30
Switzerland 0.77
UK 0.70
US 0.48
Source: Measure based on Garriga (2016).
Central Bank Independence and Monetary Stability
During the 1980s, the key macro-economic concern was the so-called Great Inflation of the 1970s. Why did
inflation prove so persistent? And what role did monetary policy play in generating this persistence? The
time-consistency theory of Kydland and Prescott (1977), Nordhaus (1975) and Barro and Gordon (1983)
provided an elegant answer to these questions. Governments had a natural tendency to over-inflate their
economies, especially around election time, generating an "inflation bias".
To curb this inflation bias, some institutional means was needed to constrain government's policy hand.
Rogoff (1985) developed a model which provided such an institutional fix. Monetary policy decisions were to
be delegated to a "conservative", inflation-minded, central bank acting independently from government. In
this way, central bank independence could prevent, at source, a return to the Great Inflation of the 1970s.
The macro-economic benefits, in theory, did not end there. Provided inflation expectations were well-
anchored and central banks were not too inflation-averse - "inflation nutters" in the language of Mervyn King -
7
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monetary policy could be effective in stabilising output in the economy too.7 In other words, central bank
independence was a potential twin-win, reducing inflation biases at no cost in increased output variability.
Empirical evidence followed to test these hypotheses. During the 1980s and 1990s, a number of papers
established a statistically significant link between the level and variability of inflation and the degree of central
bank independence across a range of countries.8 These cross-country correlations strongly suggested
central Independence was an important contributor to reduced inflation bias. And this evidence, in turn,
helped spur moves towards central bank independence in the latter-part of the 20th century.
Charts 4 and 5 plot the relationship with inflation and inflation variability and central bank independence in 18
countries based on data from 1970 through to 1999. It confirms the negative, statistically significant,
relationship between (the level and variability of inflation) and independence. Chart 6 plots independence
against output variability over the same period; it suggests independence did not result in an increase in
output variability. Taken together this evidence implies independence has, indeed, been a twin-win.
Chart 4: Independence and Chart 5: Independence and Chart 6: Independence and
Inflation Inflation Variability Output variability
Source: Bank of England Source: Bank of England Source: Bank of England
For the UK, Chart 7 plots a measure of inflation and output variability over a number of sample periods. In
the period since the Bank became independent in 1997, inflation uncertainty has fallen by a factor of around
four compared with the earlier 20-year period, while output variability has been unchanged, absenting the
7
King (1997).
8
For example, Alesina and Summers (1993).
8
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financial crisis of 2009. Consistent with international evidence, central bank independence in the UK
appears also to have been a twin-win.
Chart 7: Inflation and Output Variability in the UK
Source: Bank of England.
Chart 8: Independence and Chart 9: Independence and Chart 10: Independence and
Inflation Inflation Variability Output variability
Source: Bank of England Source: Bank of England Source: Bank of England
More recently, empirical evidence on the effects of independence has become less clear-cut. Charts 8-10
plot the same cross-country relationships since 2000. The correlation between central bank independence
9
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and inflation has all but disappeared. Chart 11 plots the rolling cross-country correlation coefficient between
the two variables to illustrate this point. Meanwhile, the relationship between independence and output
variability is now positive, if insignificant. In the UK, the outward shift in output, variability over the past
decade is also noteworthy
(Chart 7).
What explains this disappearing correlation? Some have used it to question whether the earlier link between
independence and low inflation was no more than a statistical mirage.9 It could be argued that the fall in
inflation over this earlier period was instead the result of the benign macro-economic environment of the
Great Moderation.10 In other words, better inflation outcomes in the late 20th century might have reflected
good luck rather than good central bank management. There are two reasons why this alternative reading of
the macro-economic runes is not entirely convincing.
Chart 11: Correlation between Independence and Inflation through time
Source: Bank of England.
First, it is well-known that reduced-form correlations between variables may not accurately capture the true
impact of policy, especially during episodes of regime change. An effective policy regime prevents a bad
outcome, such as high inflation, emerging in the first place, eliminating any reduced-form correlation between
the policy regime or action and the eventual macro-economic outcome. The impact of policy is, in this
sense, unobservable from reduced-form correlations.11
In the late-20th century, most countries moved towards a high central bank independence/low inflation
equilibrium. This regime shift may have effectively extinguished any reduced-form correlation between the
two. Certainly, it would be dangerous to infer from the disappearing correlation that independence did not
contribute to the shift to a lower inflation equilibrium. And it would be more dangerous still to conclude that
any reversal of this regime shift - away from independence - would have a no impact on inflation.
9
Benati (2008), Stock and Watson (2002).
10
Bernanke (2004).
11
See McLeay and Tenreyro (2019) in the context of the Phillips curve.
10
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It is revealing to look at the behaviour of inflation expectations. They are a key diagnostic on the credibility of
a monetary regime over time. If a regime is credible, these expectations ought to be anchored around the
target and relatively unaffected by short-term shocks to the economy. Chart 12 plots UK inflation
expectations, inferred from financial markets at the 3-year horizon, over the period since 1983. It also plots
measured inflation over the same period. Three distinct periods are worth identifying.
In the period prior to inflation targeting and independence, the variability of both inflation and inflation
expectations was high. Shocks to inflation were large and the credibility of the monetary regime was low. In
the period since independence up to the Global Financial Crisis - the Great Moderation - the variability of
both inflation and inflation expectations fell by a factors of between 6 and 2, respectively. That is consistent
with both the good luck (benign shocks) and good management (central bank independence) hypotheses.
Over this period, it is difficult to identify separately their effects.
Subsequent events have made identification somewhat easier. Since the Global Financial Crisis, the
variability of inflation has roughly trebled in the UK, as the incidence of macro-economic shocks has
increased. Yet over this period, the level and variability of inflation expectations has actually fallen.
Expectations have remained anchored, despite the less benign environment. This suggests an important
role for the monetary regime and central bank independence in safeguarding stable inflation.
Chart 12: Inflation and Inflation Expectations in the UK
Source: Bank of England
11
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Before concluding on monetary stability, let me add just one small fly to the ointment. Several recent
empirical studies have looked at the behaviour of inflation expectations across different household cohorts,
often finding quite large and widening differences. One of the most striking of those is between young and
older generations, with the latter tending to have higher inflation expectations, perhaps reflecting their lived
experience during the Great Inflation of the 1970s.12
Chart 13: Inflation and Inflation Expectations Across Age Cohorts in the UK
Source: Bank of England
Notes: based on 1 year ahead inflation expectations taken from the Bank's TNS Inflation Attitudes Survey.
Chart 13 plots the inflation expectations of different age cohorts in the UK. In general, and unlike in some
other countries, these age-related differences are not especially large. Nonetheless, in general inflation
expectations among young people are not only lower, but also appear to be more sensitive to actual inflation
outcomes. This, too, is likely to reflect the different lived inflation experience of young people.
12
For example, Diamond, Watanabe and Watanabe (2019) and Malmendier and Nagel (2016).
12
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If these generational patterns were to persist, they might pose a challenge to the monetary policy regime. A
less inflation-averse population, without experience of the costs of past high and volatile inflation, might
mean a less strong constituency for price stability - and, potentially, central bank independence - than earlier
generations.13 This is an interesting research question for us all. It is also a challenge central banks might
wish themselves to reflect on, as I shall discuss at the end.
Central Bank Independence and Financial Stability
Until recently, neither the theory nor the practice of central bank independence was as well developed in the
area of financial stability. That has changed since the Global Financial Crisis, with both greater amounts of
research on the financial stability benefits of independence and greater numbers of central banks adopting
independence in their regulatory and supervisory practices. Nonetheless, both remain in their infancy.
The time-consistency problem familiar from monetary policy has a clear read-across to the world of financial
stability. Governments have an incentive to run their financial systems, as well as their economies, hot in the
interests of growth and electoral advantage. This generates a tendency to loosen regulation too far during
credit booms, increasing the risk of future bouts of financial instability. In other words, there is a potential
problem of "instability bias" in regulatory policies, to accompany the "inflation bias" in monetary policies.14
In fact, I would argue this time-consistency problem is potentially greater in the financial stability sphere than
for monetary policy, for two reasons.15 Credit cycles tend to be longer in duration, and larger in amplitude,
than typical business cycles.16 This means wishful thinking and policy myopia ("this time is different") are
more likely to arise in credit booms than during typical business cycle upswings, exaggerating the time-
consistency problem of financial stability policies.
The costs of financial instabilities and crises also tend to larger than the costs of inflationary surges. This
means the temptation to act in a time-inconsistent fashion - talking tough ex-ante, but acting weak ex-post -
also tends to be greater. That can encourage risk-taking and amplify financial cycles and crises - a doom
loop.17 The Global Financial Crisis, a long-duration credit boom that prompted massive government support
was a good example of these acute financial stability time-consistency problems in practice.
ex-post,
As with monetary policy, one institutional fix for this problem is to delegate prudential policy-making to an
independent agency, better able to curb credit cycles and forestall financial crises. This helps explain the
shift towards independence in the setting of regulatory and supervisory policies over the past decade. At the
13
Shiller (1996).
14
Quintyn and Taylor (2002), Herrera et al (2020)
15
A point also argued by Bianchi and Mendoza (2018).
16
Aikman, Haldane and Nelson (2015).
17
Haldane (2012).
13
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Bank of England, this role is played by the Financial Policy Committee (FPC) for system-wide-risks, and the
Prudential Regulation Committee (PRC) for institution-specific risks.
Academics have recently begun constructing indices of independence for financial stability regimes.18 For
example, research at the Bank has developed an index of Regulatory and Supervisory Independence (RSI)
based on legal characteristics.19 Chart 14 plots this RSI for 43 countries, alongside a monetary policy-based
index of independence. The RSI starts lower but has increased rapidly since the Global Financial Crisis.
The UK has a high degree of independence for its financial stability policies by international standards.
Research has also begun to link these measures of RSI to financial stability outcomes as a test-bed of
time-consistency theory, again broadly mirroring the monetary policy literature. One additional challenge
these studies face is finding an objective and continuous measure of financial instability. Bank and other
research has often used proxies, based on Non-Performing Loans (NPLs) and the variability of the
Returns on Assets (ROA) in the banking system.20
Chart 14: Central Bank Independence and RSI
Source: Fraccaroli et al (2020)
Based on the research of Fraccaroli et al (2020), Table 2 looks at the relationship between RSI and
NPL/ROAs across a selection of countries, controlling for a range of other macro-economic and
institution-specific factors that influence NPL/ROAs. This suggests a statistically-significant, negative
18
For example, Dincer and Eichengreen (2013).
19
Fraccaroli et al (2020).
20
Klomp and den Hann (2009)
14
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relationship between the two across the 43 countries.21 In line with theory, independence in financial stability
policies is associated with a reduction in financial instabilities, as proxied by NPLs and the volatility of ROAs.
Consider a rough ready-reckoner from Table 2. The average reform to increase the independence of central
banks' financial stability policies over the past 20 years would be expected to have reduced the incidence of
NPLs across the global banking system by somewhere between 1.7 and 2.9 percentage points, on average.
Given prevailing levels of bank capital, and bearing in mind the costs of financial crises, this is a sizeable
benefit of greater independence in financial stability policy-setting.
Table 2: RSI and Financial Stability
Measures of financial stability
Non-performing loans ROA volatility
RSI Reforms -2.8*** -1.9***
[coefficient range based [-1.7 to-2.9] [-0.8 to -1.9]
on robustness checks]
An interesting supplementary question is whether independence in financial stability policies has come at
any cost in terms of the reduced efficiency of financial intermediation, perhaps because of more stringent
regulatory and/or supervisory practices. This is the financial stability equivalent of asking whether
independent monetary policies have imposed macro-economic costs through increased output variability.
Table 3: RSI and Bank Efficiency
Measures of efficiency and profitability
Net interest margin Cost to income
RSI Reforms -0.6 -1.2***
[coefficient range [-1.9 to 0.4] [-1.8 to -2.4]
based on robustness
checks]
Notes: *** means coefficient significant at the 1% level. Full list of controls for benchmark regressions and alternative
specifications can be found in HLM (2020)
21
Fraccaroli et al (2020).
15
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Table 3 looks at the relationship between RSI reforms and two measure of banking system efficiency (net
interest margins and the cost to income ratio) across banks in 43 countries.22 As with monetary policy, it
finds no evidence of independence in financial stability policies having come at an efficiency or competitive
cost.23 In other words RSI, like its monetary policy counterpart, appears empirically to be a twin-win, with
reduced financial instability coming at no discernible macro-economic cost.
Central Bank Independence and Fiscal Stability
A final dimension of the independence debate, and one of growing interest, is the way it interacts with fiscal
policy. With central banks globally now owning around one-fifth of the outstanding stock of government debt
as a result of QE, this increasing interest is not surprising.
Central bank balance sheet expansions have, for some people, blurred the distinction between monetary
and fiscal policies and posed questions about central bank independence. Fortunately, there is a rich
literature to help clarify some of these links between fiscal and monetary policies.24 Although I do not have
time to do that justice here, one or two general lessons are worth bringing out.
First, it is clear that fiscal policy actions can have significant effects on the macro-economic variables that are
part of central banks' mandates, such as output and inflation. In the current environment, fiscal policy is
highly expansionary and providing considerable support to activity and inflation, in the UK and globally,
alongside the effects of the expansion of monetary policies.
Second, these macro-economic spill-over effects of monetary and fiscal policies could, in principle, lead to
these policies acting at cross-purposes or imposing "externalities" on each other. Provided both the fiscal
and monetary authorities have clear mandates, however, which they then pursue independently, this conflict
will rarely arise.25 Both bodies then simply take into account the choices being made by the other body when
determining the policies necessary to meet their mandates - they internalise the externalities. In the Bank's
case, this means taking account of the fiscal stance when judging the monetary policy stance necessary to
meet the inflation target.
Third, the optimal balance of monetary and fiscal policies is not necessarily fixed over time and may change
as we approach the zero lower bound (ZLB) on interest rates. Specifically, to the extent the ZLB reduces the
effectiveness of monetary policy relative to fiscal policy in stimulating demand, this may justify a somewhat
larger role for fiscal policies in the face of a shock to activity.26 In the current environment, facing such a
shock, fiscal policy has provided more of the support to demand than during the Global Financial Crisis.
22
The efficiency measure is taken from Barth et al (2013).
23
Barth et al (2013) reach a similar empirical conclusion.
24
For example, Leeper and Leith (2016).
25
Bhundia and O'Donnell (2002).
26
Eggertsson (2011).
16
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Fourth, as both monetary and fiscal policies both act to support demand, it is natural to see them expanding
in lockstep through increased government spending and higher QE in the current environment. As my
colleagues on the MPC have clearly set out, this is not a sign of one policy driving the other, much less of
monetary financing of government deficits.27 Rather it is a reflection of both policies responding
counter-cyclically, as they should, in the face of a very large cyclical shock to aggregate activity.
Nor should a rise in the proportion of debt held on central banks' balance sheets be taken as a sign of
so-called fiscal dominance.28 The latter arises when monetary objectives, such as