Reflections on the Past and Future of Central Bank Independence
Seminar on The Relevance of Central Bank Independence: Challenges and
Outlook/Banco de México
Pablo Hernández de Cos
Governor
Good morning. It is my pleasure to participate in this conference on the occasion of the 25th
anniversary of the autonomy of the Banco de México. I take the opportunity to congratulate
you on this landmark. Events such as this contribute to highlighting the relevance of the
independence of monetary authorities, and my words today will be along these lines.
In my address I shall first briefly refer to the independence of the Banco de España, both as
a national central bank in itself but also as a member of the European System of Central
Banks. Then, I would like to share with you some more general thoughts about current
challenges to central banking from the perspective of their independence.
The independence of the Banco de España
The Banco de España was granted institutional independence in July 1994. So this year, as
is also the case for the Banco de México, marks the 25th anniversary of our Law of
Autonomy. The independence of the Banco de España came about as part of the European
economic integration process. Following the requirements laid down in the Maastricht
Treaty, central banks in the European Union were meant to pursue the primary objective of
price stability and be vested with a large degree of independence, both political and
operational. Participation in the monetary union also entailed a change in the relationship
between Treasury and central bank so as to incorporate the prohibition of monetary
financing of government deficits.
Central bank independence was granted with a large degree of legal protection and, as a
matter of fact, no country in the European Union can change it at its own discretion. Of
course, the independence of the central bank does not mean arbitrariness, as it is well
counterbalanced by high transparency and accountability requirements and practices.
Granting independence to the Banco de España some years before the introduction of the
euro as a common currency reflected Spain's strong ambition to become a founding
member of the European Economic and Monetary Union. It was also the result of a firm
political conviction as to the benefits of price stability and the advisability of delegating the
pursuit of this goal to an independent central bank. Price stability requires a medium-term
orientation and the independence of the monetary authority creates credibility by helping to
keep inflation expectations anchored while avoiding time inconsistency problems.1 These
reasons were particularly compelling for the Spanish economy in light of the previous
experience of relatively high inflation.
Figure 1
INFLATION RATES
1970-1994
1994-1998
%
%
25
5
20
4
15
3
10
2
5
1
0
0
70 72 74 76 78 80 82 84 86 88 90 92 94
94 95 96 97 98
EURO AREA SPAIN
The independence of the Banco de España, along with the new monetary policy framework
based on direct inflation targets, was decisive in bringing inflation down and in fulfilling the
Maastricht requirements in a short period of time.2 In this regard, the Spanish experience in
relation to EMU accession meant a qualitative leap forward in terms of credibility,
communication and transparency, which facilitated the anchoring of inflation expectations
to a new regime of price stability, providing a focal point for collective wage bargaining, the
setting of regulated prices, etc.
The task of taming inflation did not fall entirely on the shoulders of the Banco de España, as
Spain showed a strong and credible political will to lower inflation that helped bring about
the anchoring role of the whole European institutional setting.
With the launch of the euro, two decades ago, the Banco de España started to participate
in the formulation and implementation of the euro area common monetary policy. Governors
from the national central banks in the euro area are members of the Governing Council of
the European Central Bank, a collegial decision-making body. Governors do not represent
national interests and they vote in their own capacity considering the interest of the euro
area as a whole.
National central banks in the euro area can also carry out other functions as long as they do
not interfere with their responsibilities in the common monetary policy. For instance, the
Banco de España is the national competent authority for banking supervision. However, all
these additional functions do not necessarily enjoy the same level of independence3 as the
monetary policy tasks conferred by the Treaty. With the creation of the Single Supervisory
Mechanism (SSM) in 2014, the Banco de España's supervisory role was integrated into a
new institutional framework with the European Central Bank at its core. I will come back to
this function later on.
Some lessons on central bank independence
Let me share with you some reflections about central bank independence nowadays. This
will be in the form of five lessons which, in my view, should be kept in mind when thinking
about central bank independence, particularly at the current juncture of seemingly tamed
inflation but with difficulties in achieving price stability objectives in some advanced
economies.
1. Institutional settings matter
First, I would state that independence, to be effective, must rest on a robust legal and
institutional framework. Independence must be formally recognised in all of its relevant
dimensions: namely, at the institutional, functional, personal and financial levels. This is the
case in the euro area, where the Maastricht Treaty4 provided the appropriate framework;
but unfortunately it is not the case in other regions, thus making the task of central banks
much more complicated.
2. The need to deliver
Second, the main reason for central bank independence is a utilitarian one: independence
is an instrument to enhance effectiveness in order to achieve agreed objectives in the
general interest, such as price or financial stability. The social value of central bank
independence is thus inextricably linked to the effectiveness of its policies. The corollary is
clear: central banks should employ the full set of instruments available to them to fulfill their
mandates.
Central banks are entrusted with the fulfilment of a precise set of objectives and, to do this,
they are given the powerful tool of independent statutes. But trust must be earned daily and
backed by hard evidence (on our effectiveness), and not based on faith or belief.
3. The extension of independence to other economic policy functions
Third, we should bear in mind that the time-inconsistency argument for an independent
monetary authority is also relevant - and thus, may also be applied - to the need for an
independent financial supervisor, as short-term incentives to relax supervisory policies may
have important consequences over financial stability in the long run. In turn, this may also
influence monetary policy-making. And this argument applies both for micro-prudential and
macro-prudential supervision.
Regarding micro-prudential supervision, the importance of independence in this field,
besides its relevance in monetary policy, is actually a worldwide recognised standard
enshrined in the Basel "Core Principles for Effective Banking Supervision"5. The Basel Core
Principles are part of the "Key Standards for Sound Financial Systems"6 determined by the
Financial Stability Board (FSB) that deserve priority implementation depending on
countryspecific circumstances. Moreover, implementation of these principles is generally assessed
through the IMF/World Bank Financial Sector Assessment Programs (FSAP7).
In the Euro area setting, the creation of the SSM in 2014 added this dimension of
independence.8 However, building a system of banking supervision in the euro area in
parallel with the monetary union posed challenges from the perspective of central bank
independence. In particular, it could raise concerns of potential conflicts between the
prudential supervision of European banks and the primary goal of price stability. This was
foreseen in the institutional design of European supervision, assigning to the Supervisory
Board - a new body within the European Central Bank - the planning and execution of the
supervisory tasks. In consequence, separation between monetary policy and supervision
was a key pillar for the conferral of supervisory tasks on the European Central Bank.
Regarding macro-prudential supervision, the European institutional setting promotes its
independence as the European Systemic Risk Board recommends central banks have a
10
prominent role in national macro-prudential authorities.9 In the Spanish set-up, the Banco
de España is entrusted with deciding independently when macro-prudential tools regarding
5
See Core Principles for Effective Banking Supervision - Basel Committee on Banking Supervision (September 2012)
https://www.bis.org/publ/bcbs230.pdf
6
For more information about the Key Standards for Sound Financial Systems, see the FSB website:
https://www.fsb.org/work-of-the-fsb/about-the-compendium-of-standards/key_standards/
7
For more information about FSAPs, see the World Bank website:
https://www.worldbank.org/en/programs/financial-sector-assessment-program
8
See article 19 of Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European
Central Bank concerning policies relating to the prudential supervision of credit institutions:
1. When carrying out the tasks conferred on it by this Regulation, the ECB and the national competent
authorities acting within the SSM shall act independently. The members of the Supervisory Board and the
steering committee shall act independently and objectively in the interest of the Union as a whole and shall
neither seek nor take instructions from the institutions or bodies of the Union, from any government of a
Member State or from any other public or private body.
2. The institutions, bodies, offices and agencies of the Union and the governments of the Member States and
any other bodies shall respect that independence.
https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013R1024&from=en
9
See Recitals 7 and 12 and sub-recommendation B3 of "Recommendation of the ERB of 22 December 2011 on the
macro-prudential mandate of national authorities" (ESRB/2011/3):
https://www.esrb.europa.eu/pub/pdf/recommendations/ESRB_2011_3.en.pdf
10
See Recital 24 of Regulation No 1092/2010 of the European Parliament and of the Council on European Union
macroprudential oversight of the financial system and establishing a European Systemic Risk Board:
The ECB and the national central banks should have a leading role in macro-prudential oversight because of their
expertise and their existing responsibilities in the area of financial stability. National supervisors should be involved in
providing their specific expertise. The participation of micro-prudential supervisors in the work of the ESRB is essential
to ensure that the assessment of macro-prudential risk is based on complete and accurate information about
developments in the financial system. Accordingly, the chairpersons of the ESAs should be members with voting rights.
One representative of the competent national supervisory authorities of each Member State should attend meetings of
the General Board, without voting rights. In a spirit of openness, 15 independent persons should provide the ESRB with
external expertise through the Advisory Scientific Committee.
https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=OJ:C:2016:202:FULL&from=EN
the banking sector should be activated or deactivated. Accordingly, other sectoral financial
regulators are given responsibilities for activating their own tools.
In particular, the Banco de España is now empowered to require that banking institutions
establish countercyclical capital buffers by credit segment, limits on concentration in
relation to economic activity sectors, and limits and conditions when underwriting new loans
(in terms of loan-to-value, loan-to-income and debt service-to-income ratios, and also the
maturity, the currency in which the operation is denominated and whether the interest rate
is fixed or variable, among others). These new instruments complement those previously
available to the Banco de España and included in the European legislation:11 the
countercyclical capital buffer, the systemic risk buffer and the buffer for systemic banks,
among others.
In addition, this year saw the creation of the Macroprudential Authority Financial Stability
Council, whose main goal is to contribute to the promotion of coordination and the
exchange of information on financial stability issues among the Banco de España, the
Ministry of Economy and Enterprise, the Spanish National Securities Market Commission
and the Directorate-General of Insurance and Pension Funds). All in all, this new institutional
setting is a significant step forward in reinforcing financial stability in Spain.
4. Other policies should also promote economic and financial stability
The notion that other economic policies should complement monetary policy and also
contribute to economic stability has always been embedded in the design of the European
Economic and Monetary Union. As such, from the start, the Maastricht convergence criteria
went beyond inflation to also include targets in terms of fiscal discipline.12
The Spanish experience in the effort to comply with these criteria illustrates and reinforces
the critical importance of other policies, such as fiscal consolidation or liberalisation reforms.
This is an important lesson not to be forgotten: central bank credibility is an essential
element for the effectiveness of monetary policy, but monetary policy is more efficient when
11
The CRD IV/CRR regulatory package makes available a set of macroprudential instruments that national competent
authorities can resort to with a view to preventing the emergence of cyclical systemic risks or mitigating structural
systemic risks, such as: a) the capital conservation buffer; b) the countercyclical capital buffer; c) the buffer for other
systemically important institutions; d) the systemic risk buffer. Regulating capital buffers aimed to (i) ensure a level playing
field between EU Member States, as an essential pre-requisite for the functioning of the internal market, (ii) prevent
regulatory arbitrage, (iii) ensure maximum harmonisation, and (iv) enhance transparency and predictability in the
macroprudential field. See articles 130, 131,133, 134,135-140 of CRD IV.
https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013L0036&from=EN
https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:32013R0575&from=EN
12
See Hernández de Cos: El reto de la unión fiscal europea (2014):
In response to the euro area sovereign debt crisis, there has been a deep reform of fiscal governance in the European
Union. This reform includes a strengthening of the corrective arm of the Stability and Growth Pact, with the setting of a
ceiling on public spending and the introduction of greater coordination in countries' budgetary processes. In the
corrective arm, greater significance is accorded to the debt criterion and the sanctions system has been reinforced.
Members are obliged to reform national fiscal frameworks and set up independent fiscal authorities, which must conduct
public assessments regarding the implementation of national budgetary rules. Overall, the reform echoes the latest
economic literature, which stresses that it is the design and not only the mere existence of fiscal rules that has a bearing
on their effectiveness. However, the new framework of governance is now more complex and the room for discretionality
in its application remains ample. Its effectiveness will thus depend on such application being strict.
Full article available in Spanish: https://www.funcas.es/Publicaciones/Sumario.aspx?IdRef=1-01141
For more information on the reform of the economic governance in the Economic and Monetary Union see Caballero,
García Perea, Gordo (2011) available in Spanish:
https://www.bde.es/f/webbde/SES/Secciones/Publicaciones/InformesBoletinesRevistas/BoletinEconomico/11/Ene/Fic
h/art5.pdf
coupled with and complemented by an appropriate balance in overall economic
policymaking.
Actually, beyond accession criteria, this notion was also enshrined on an ongoing basis
through the Stability and Growth Pact and, later on, with the Macroeconomic Imbalance
Procedure. This latter check on structural and broad macroeconomic policies was the
response to the hard-learnt lesson (especially in countries like Spain) that a lack of
competitiveness and excessive credit cycles could seriously hamper the optimal conduct of
monetary and financial policies and usher in financial fragmentation.
Also, strictly in the realm of monetary policy, fulfilling our price stability mandate has become
more challenging in recent times. Natural interest rates in the main advanced economies
have been gradually falling over the last three decades and they currently stand at
historically very low and possibly negative levels. There are also good reasons to think that
natural rates may be stuck at very low levels for long periods. This, in conjunction with a
lower bound for policy rates, seriously curtails the space for conventional monetary policy.
Unconventional measures, such as asset purchases, negative interest rates and forward
guidance, have helped us to partially overcome the lower bound constraint, thus becoming
a necessary tool in our monetary policy framework. Notwithstanding, unconventional
measures have their own limitations.
In this context, inflation will ultimately be the outcome of the interaction between a number
of factors. In order not to overburden monetary policy, it is essential to achieve a balanced
policy mix. Such mix should include long-term growth-enhancing fiscal policies and
sufficient structural reforms that increase productivity.
Preserving central bank independence thus requires acknowledging this interaction among
policies and, hence, it is the duty of central bankers to call for an appropriate mix of
economic policies that help us achieve our price stability goal while minimising potential
side effects.
The specificity of the euro area, with a common monetary policy and 19 different fiscal and
economic policies, considerably increases the complexity of finding the right alignment of
economic policies. The aggregation of national fiscal policies does not necessarily translate
into an adequate fiscal stance for the euro area as a whole. In short, the current euro area
institutional architecture does not allow for a systematic implementation of an active fiscal
policy based on targeted, timely and temporary measures. Thus, the absence of a common
fiscal capacity in the euro area makes it difficult to achieve an appropriate policy mix.
Building this fiscal capacity, with adequate size and design, should be a priority on the
agenda.
The Eurosystem should continue to push for more growth-enhancing reforms at the national
and European levels and for the completion of a more robust euro area institutional setting.
This includes completing the Banking Union, the Capital Markets Union and creating a
stabilising central fiscal capacity that will help the euro zone economy reduce its
vulnerabilities and better weather potential future episodes of stress.
This brings me to highlight one further dimension of the value of central bank independence.
Independence contributes to the role that monetary authorities tend to play with respect to
other policies. Their technical recommendations, free of short-term political pressures or
vested interests, may provide valuable guidance for other economic policies. Although this
function is not always formally incorporated into the legal framework, in the case of the
Banco de España this role is recognised in our Law of Autonomy. Indeed, this legislation
establishes a function to "advise the government", which supports our role in evaluating
other public policies. This is also the case of the European Central Bank, on which the Treaty
confers an advisory function with regard to proposals for European Union and Member
States' legislation within its fields of competence.
5. The key importance of transparency and accountability
The fifth and final reflection concerns highlighting the importance of pursuing the highest
standards of accountability and transparency vis-à-vis both society and the political
representatives. Indeed, accountability and transparency support both the effectiveness
and also the legitimacy of central bank independence. We need to keep in mind that
monetary policy is now more complex and society is constantly raising the bar for these
standards.
The adoption of unconventional tools marked a shift away from the "one goal, one
instrument" policy setting in which accountability was easier. More instruments at play might
have also raised concerns about the possibility that central banks have stepped beyond
their mandates, thus potentially endangering the public perception about the value of their
independence. Yet allow me to emphasise that, in parallel, central banks have strengthened
transparency by providing the general public with extensive information about the rationale
behind these monetary policy measures within our existing mandates.
In particular, in the case of the Governing Council of the ECB, the accounts of our monetary
policy meetings are published and the President and Vice-president hold a joint press
conference with a Q&A session after each decision. In addition, members of the Governing
Council routinely engage in public events and deliver speeches to explain our decisions and
the rationale behind them. And, of course, the President of the ECB regularly participates in
sessions with members of the European Parliament as do governors of national central
banks in their corresponding parliaments.
I deem it essential to persevere in this direction to reinforce the democratic accountability
of the central bank.
In communication with the public, central banks should carefully balance the need for clarity
and the intrinsic complexity of monetary policy decisions. To strike the right balance it is
worth noting that transparency does not mean providing certainties on intrinsically complex
issues but clarity on the inevitable uncertainties and trade-offs that affect monetary
policymaking. An added difficulty in the euro area is having to communicate to citizens from 19
different countries in which public opinion sometimes focuses more on national affairs than
on European issues.
On top of high transparency standards, we should explore additional tools that could
contribute to reinforcing the legitimacy of an independent public institution. In fact, I find
that public policy evaluation could be a key and powerful tool in this regard. A periodic
evaluation of the central bank's performance and impact in the pursuit of its objectives could
be a very potent mechanism as regards accountability to citizens.
Despite all these challenges, let me conclude my intervention by saying that I remain
optimistic about the ability, determination and capacity of independent central banks to
keep on providing valuable services to the societies we serve.
Thank you very much.