Central bank independence is once again a subject of active, public debate. Recent developments, especially in light of the great financial crisis of 2008, veiled – and explicit – threats from political quarters in the United States, Great Britain, Turkey, India and elsewhere, have raised concerns that it needs to be strengthened.
The business and financial world are well aware of the vital role played by central banks in ensuring economic growth and stability, from fighting inflation in the 1970s, to promoting the recovery from the great recession ten years ago. Some worry whether the continued role of central bankers as the “responsible adults” can no longer be taken for granted.
As The Economist recently wrote: “The administration’s attacks on the Federal Reserve have undermined confidence that it will act as a lender of last resort for foreign banks and central banks that need dollars, as it did during the financial crisis”. Others wonder if it is no longer needed, or no longer beneficial and should not be maintained.
Central bankers themselves are well aware of the limits of central bank independence. As a former central banker myself, I know that many of my colleagues around the world are “looking over their shoulder” to ensure that they do not push independence too far, in case they provoke other branches of government or the public. Even when monetary independence is protected in the law, central banks must also consider issues of financial stability, growth and employment, and most recently, the distributional impact of policies on society.
It is easy to forget that central bank independence has never been a goal in and of itself. It is an attempt to deal with problems arising from possible conflicts when central banks make monetary policy for sovereign currencies alongside governments with different interests. It is a method of mitigating problems arising from the dominance of governments.
The first was the problem of time inconsistency: when monetary decisions are made by politicians, they can be influenced by short term and electoral considerations. Independent central banks are free to take a longer-term view with superior overall results. Independence can also reduce possible conflicts of interests, or distractions from pursuing the correct monetary policy, stemming from fiscal, supervisory or personal considerations. However, it raises other concerns, such as accountability to the public, and the transfer of important decisions to unelected officials.
What if central bank independence became irrelevant? Central banking has always had to evolve and respond to changes in technology, society, and the economy. We are now facing new challenges and need to add new dimensions to monetary management. What if a monetary model existed that was not subject to the flaws that independence is meant to remedy?
“Central bank independence is meant to remedy interference from governments seeking to attain electoral advantage, devalue their debt or impose an inflation tax. This is an issue in the case of sovereign currencies, where there is always a government, with its own interests to consider -and considerable power. But if there was a truly non-sovereign – yet non-private – currency, the problem would not exist”
This is not unprecedented: when monetary policy is rule-based, such independence is largely irrelevant. Examples include the gold standard, as well as currency board arrangements in which a currency is fully backed by reserves in other currencies. It is not a coincidence that the issue of central bank independence became a topic of discussion after the breakdown of Bretton Woods and the predominance of pure fiat currencies.
Are there viable alternatives? Algorithmic and code-based decision making is assuming greater importance in all areas – from driving cars and piloting aircraft to making complex legal and medical decisions, and financial and economic decision making. Embedding a monetary model governing a currency in transparent and immutable code is already achievable and would eliminate many of the vulnerabilities that central bank independence is designed to remedy. Rules would replace discretion, code is not susceptible to pressure – and the risk of giving in to pressure, biases or conflicts of interest would be reduced.
Modern technology, specifically blockchain, has also provided us with the means to establish non-centralised governance, by means of distributed ledger systems. When decisions are made by the relevant community, and their interests are aligned, conflicts of interest are eliminated, agent-principle issues disappear, personal biases are reduced, accountability is inherent, and independence is assured.
Going one step forward, an even more fundamental question can be raised: independent of what? Central bank independence is meant to remedy interference from governments seeking to attain electoral advantage, devalue their debt or impose an inflation tax. This is an issue in the case of sovereign currencies, where there is always a government, with its own interests to consider – and considerable power. But if there was a truly non-sovereign – yet non-private – currency, the problem would not exist.
Although not perfect, sovereign-government-issued currencies have contributed greatly to economic progress. They will continue to be the best way to transfer value within national boundaries, but those boundaries are becoming less relevant for an ever-increasing range and share of modern economic activity.
A truly global currency could assume an important role. If that currency was non-sovereign and at the same time not private, had a transparent monetary policy embedded in code and substantially non-centralised governance, independence would ultimately become irrelevant.
Barry Topf is the Chief Economist at Saga Foundation. He had a 33-year career at the Bank of Israel, where he served as one of the founding members of the Monetary Policy Committee and as Senior Advisor to the Governor, Stanley Fischer. He also held positions of Head of Market Operations, Head of the Foreign Currency Department, and Chief Investment Officer. In his capacity as an IMF consultant, Topf has advised over 25 countries on economic policy.