Over recent decades, central banks have gained new powers. Nowadays, they are involved in areas as diverse as the greening of the economy and digital finance. But is it a problem, wonder Lucia Quaglia and Amy Verdun, that despite their broader role, central banks remain independent from politicians?
During the Great Financial Crisis of 2008 and the Covid-19 pandemic, central banks intervened rapidly and massively to prevent the worst. First and foremost, they acted as lender of last resort to banks, and to each other through swap lines. The subsequent recession saw central banks performing as ‘recession fighters’ of ‘second resort’ by engaging in unconventional monetary policy, adopting various measures of quantitative easing (QE).
Central banks expanded their toolbox and interpreted their price stability mandates more flexibly. In response to low inflation, they deployed new tools such as asset purchase programmes in the financial sector. In the public sector, they rolled out various types of QE.
As central banks developed additional policy objectives and new policy instruments, they broadened their mandates. And as they entered the political realm, central banks’ policies became more political.
Some politicians, especially those on the right and those of a more populist leaning, have become critical of independent central banks. When banks had a narrow and clear mandate, justifying their role had been relatively easy. Now that central banks must juggle several (at times competing) objectives, it is more difficult to defend central bank political independence.
Now that central banks must juggle several (at times competing) objectives, it is more difficult to defend central bank political independence
Think about it this way: policy actions involve political choices, so they have an impact on redistribution. Yet, central bankers are not elected, and their independence is designed to keep executives and legislatures at arm’s length. The distributional implications of monetary policy to keep inflation low using usual tools are complicated and nuanced. The so-called ‘unconventional monetary policies’ generate more clear-cut winners and losers than ‘conventional’ monetary policies. This situation exacerbates socio-economic inequalities, and raises the question of whether central bankers should take a moral stance on it.
During recent economic crises, central banks stepped up to the plate because politicians were not responding quickly or effectively enough. Central banks often bought the political authorities time to act, which their democratic deliberative processes required. In this way, central banks were leading because others were not.
In the European Union, the challenge is that there is no single fiscal authority, no EU-level Treasury or minister of finance. Instead, the national fiscal authorities must coordinate before they can act in concert. By contrast, the European Central Bank (ECB), the EU-level monetary authority, is a supranational actor, independent from national governments. It is therefore easier for the ECB to take quick, decisive actions.
EU member states' national fiscal authorities must coordinate before they can act in concert. But the ECB, independent from national governments, can take quick, decisive action
Central banks have also become active in another area where politicians have been a bit slower, namely, to promote the green and digital transition. (Their actions, however, have not impressed everyone.) Central banks have argued that their new interest in greening the economy is part of their wider understanding of what it takes to ensure financial stability and monetary policy goals.
Perhaps surprisingly, given China's carbon footprint, the People’s Bank of China has become a frontrunner in greening the economy. Some of its motivation is reducing domestic pollution, but the distinctive domestic institutional structure and political context has helped.
The ECB has discovered the green transition, not only by setting its own policies but also by exchanging views with other central banks, and through international-level cooperation. PBC and ECB have taken a leadership role in exploring central bank digital currencies, which is how central banks engage with the digital economy, and digital finance in particular. But central bank digital currencies also have geoeconomic implications, and could be tools of financial statecraft.
Central bank independence had originally been established to secure price stability, but the challenges today are different, and the banks have expanded their roles accordingly. Yet, as this happens, the status of central banks as independent from politicians becomes more controversial. There is less trust today in elites and technocracies. There is also the risk of independent regulatory agencies being captured by elected politicians who may populate them with experts sympathetic to their views.
There is an increasing risk that central banks could be 'captured' by governments who populate them with experts sympathetic to their views
Currently, populist parties and those with conservative and right-leaning tendencies are giving central banks a run for their money. We therefore need to re-examine the legitimacy of central bank independence in the changing geoeconomic world, where populist and anti-establishment political parties have gained substantial electoral shares.
