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Could independent central banks be advisory?

With fiscal councils (or Independent Fiscal Institutions) now commonplace in advanced economies, a natural question arises. Why are all these councils advisory, while independent central banks have control over monetary policy? For fiscal policy we seem to have delegated advice [1], while for monetary policy we have delegated control. In this post I want to focus on control over how policy instruments are changed, and not control of the goals of policy. For clarity assume that governments still control the ultimate goals of monetary policy (e.g. an inflation target) and fiscal policy (e.g. a target for the deficit in 5 years time).

As fiscal councils are the less familiar, it is natural to try and answer this question by asking why fiscal councils are not given control over fiscal policy. I am, of course, not talking about controlling the detail of government spending or taxes, but instead setting a target for the projected deficit which governments should aim to achieve in a budget. There are lots of potential answers to that question, which I have written about elsewhere.

However we could ask the question the other way around, and I cannot remember anyone asking it this way. Why are there no independent advisory central banks? In the UK, for example, imagine having the MPC meeting, and then immediately advising (in secret for a short time) the Chancellor of their recommendation for interest rates. The Chancellor would very quickly (within an hour or day?) decide whether to accept that recommendation or do something different. After that, the decision and the MPC’s recommendation would be announced.

Two straightforward points. First, a system of that kind could only work in the US if Congress gave the President the power to accept the Fed’s recommendation or impose the President’s own decision: perhaps not something we would want to contemplate right now. In the Eurozone the ECB would have to give recommendations to Ecofin, which might make it both impractical and perhaps undesirable. Second, this form of delegation is obviously weaker than giving complete control to the central bank, and that in itself may be a reason why it is not adopted.

Nevertheless, for a country like the UK, it would be a mistake to underestimate the political pressure the Chancellor would be under to accept the central bank’s public advice. The Chancellor or Treasury minister would be entirely responsible from deviating from the recommendation given to them, and if it went wrong they would incur a considerable political cost. In these circumstances, it would be understandable for governments to reason that there was little to be gained from having the power to overrule central bank advice. They would get it in the neck if they overruled this advice and turned out to be wrong, but equally if the MPC make mistakes they would also have ultimate responsibility for accepting this advice. If in practice nearly all of the time they are going to accept the central bank’s recommendations, why not give them complete control so that at least you are not implicated when things go wrong.

If this reasoning is correct, it raises a difficult question for those who argue against central bank independence but still accept monetary policy’s primary role in stabilising the economy outwith the ZLB. Of course many governments used to be happy to control monetary policy, as long as the advice they were getting was secret. But if that advice is public, as surely we all agree it should be, would even formally advisory central banks start to in effect control monetary policy because governments would never incur the risk of going against their advice? In which case, why so much fuss about independent central banks that do control monetary policy being undemocratic? I stress again that I’m talking about control of month to month interest rate changes, and not the goals of monetary policy (inflation targets or NGDP targets). I think those should be democratically decided (as in the UK, but not the US or EZ), and that central banks should be accountable in a meaningful way if they do not achieve these goals. But for the day to day business of setting rates, I cannot see that much would be gained by putting those under democratic control. 

[1] In the absence of delegating advice to an independent institution, advice would come from the the internal civil service. 

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