SAFEGUARDING CENTRAL BANK INDEPENDENCE1
Javier Guzmán Calafell2
The broad turn towards central bank independence can be traced back to the
1970s and 1980s. Many countries were experiencing high inflation. Therefore,
attention focused on overcoming 'time inconsistency', a problem inherent to
monetary policy. This is the risk that policymakers, for political reasons, will
aim for short-term gains through expansionary policies, since their costs will
not be visible immediately. Proposals to enhance central bank independence
emerged as a viable device to face these challenges.
The case for independence has strong underpinnings, but there has been
growing doubt over its merits. This was initially a consequence of the monetary
policy response to the 2008 financial crisis, particularly in the largest advanced
economies. First, amid low inflation, some argued central bank independence
was no longer justified. Second, as major central banks implemented
quantitative easing measures, there were concerns these institutions would
end up shaping fiscal policy, which is beyond their remit. Third, greater central
bank involvement in financial stability raised doubts about entrusting them
with too many endeavors, and on the consistency of these tasks with
independence. Fourth, detractors of independence identified it as an obstacle
to coordinate monetary and fiscal policies, while also worrying about the
distributional implications of quantitative easing.
These arguments are paradoxical. In the absence of an adequate and timely
reaction by fiscal and structural policies in the aftermath of the financial crisis,
monetary policy became the only tool to bolster the world economy. There are
also strong indications that, without independence, central banks would
probably not have been able to undertake the measures needed to face the
crisis.
Furthermore, the above-noted question marks about the merits of central
bank independence can be easily refuted:
 Independence is still needed in a low-inflation environment. Inflation
declined partly as the result of the recessionary effect of the financial
crisis. There are other factors helping to contain inflation, but their
future potential impact is uncertain.
 Trade-offs with financial stability goals have always existed, as well as
incentives to consider them.
 Consistency of public finances with central banks' goals is the key issue
for proper coordination between fiscal and monetary policies. This does
not imply, though, that central banks should be stripped of their
independence.
 Over the long run, the distribution of resources owes mostly to fiscal,
structural and institutional factors.
Fresh criticisms against central bank independence have come to the fore
recently. These are politically motivated and their dissemination across both
advanced and emerging market economies is alarming. They are again the
result of developments following the financial crisis and have found
widespread support among those disenchanted with globalization. This is
particularly worrying in emerging markets, since their institutional frameworks
are more vulnerable to tensions.
Failing to protect central bank independence would cost the economy dearly,
especially in emerging markets. Their central banks' primary mandate-price
stability-would be jeopardized. It could entail a return to time-inconsistent
monetary policies, with potentially severe macroeconomic and financial
implications.
Many arguments support central bank independence. To deal effectively with
price pressures, institutions need a long-term perspective, insulated from
political considerations. They should be able to respond quickly to changing
conditions, and have the technical competence and credibility to do so. Central
bank independence has been key to stabilizing long-term inflation
expectations and overcoming episodes of distress in many countries.
Destroying the institutional framework that has made these achievements
possible would be irrational.
Granted, central bank independence must be accompanied by checks and
balances. Clear and transparent goals must be in place, and central banks must
be held accountable. Existing concerns cannot be ignored. This is a time to
reflect on what actions are needed to improve public understanding of the role
of these institutions and the importance of their independence. Elected
officials usually define central banks' mandates and the mechanisms to ensure
accountability. However, central banks should guarantee that policies
implemented are fully consistent with their mandates, and continuously
evaluate means to enhance their transparency and accountability.