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When Gordon Brown made the Bank of England independent, they queued up to praise him. Even today, when economists look back upon his time as chancellor, they say: “Well at least he made the UK’s central bank independent.”  However, right now, the principle of an independent central bank no longer seems sacrosanct.


Of course not everyone welcomed Brown’s move. You may recall that former chancellor Ken Clarke was scathing of it. Perhaps in the years that followed when Brown won his plaudits, Clarke lost some credibility.

And since the late 1990s, the independence of central banks has become a global thing.  Governments that tried to dictate to central banks were seen as beyond the pale.

It somehow seemed fitting that Argentina’s President Cristina Fernández de Kirchner fired the boss of Argentina’s central bank Martín Redrado when he refused to sanction the central bank buying up government debt. “What a tin pot country with a tin pot economy!” said the critics.

But not many people use such phrases to describe Japan. Yet Japan’s new Prime Minister (sort of new because he has held the position before) Shinzo Abe has pretty much told Japan’s central bank to independently agree with him or it will lose its independence.

German central bankers are worried. Recently the President of Germany’s central bank Jens Weidmann made a speech in Frankfurt in which he said: “It is already possible to observe alarming infringements, for example in Hungary or in Japan, where the new government is massively involving itself in the affairs of the central bank, is emphatically demanding an even more aggressive monetary policy and is threatening an end to central bank autonomy.”

In his speech, Mr Weidmann looked back on the 1990s and noughties as a kind of golden age of central banking. He said that independence of central banks created an environment of low inflation. He called it the Great Moderation

For obvious reasons some find Mr Weidmann’s comments extraordinary.  “Surely,” they say, “the era we used to call the Great Moderation, or NICE (non inflationary consistently expansionary) in the UK, was an illusion.”

Perhaps, however, the problem was not so much independent central banks, rather it was their mandate. The Bank of England was supposed to keep inflation at 2 per cent. The Fed, in contrast, is supposed to target both inflation and unemployment. Some say that is why the US has not performed as badly as the UK during the last few years. The ITEM Club from Ernst and Young made this exact point quite recently. See Bull and bear: ITEM Club calls for changes in monetary policy 

Now the talk is about changing the central bank’s target to nominal GDP – that is GDP without allowing for inflation. So if the bank targets growth in nominal GDP of 5 per cent, if we have zero growth, that means 5 per cent inflation would be consistent with the target.

Meanwhile, former MPC man and arch dove, Adam Posen has used the ‘FT’ to have good old go at the Bank of England. He said: “Supervision of the executive was very lax and there was a very strong culture and precedent that, if the governor or the broader bank executive made a decision to do something … then it was seen [that] there was no point in challenging them.” See: Posen attacks Bank of England’s culture 

Mr Posen’s point seems to be that the problem is not so much lack of independence of the central bank, rather it is that lack of independence of the people who work below the governor, or who are supposed to supervise him.

I have two points to make. The first is superficially quite controversial, but I don’t think it should be. It relates to German history. Germany hyperinflation arising out of the Weimar Republic was a consequence of the Treaty of Versailles and the cost imposed on Germany by the winners of World War 1. Today Germany fears inflation and money printing, because this arguably led to the Nazi party. In contrast, the Nazi party followed Keynesian type policies before the phrase Keynesian economics had been invented. Given the circumstances of that time, the policies were relatively successful.  But, as we all know, the Nazi party was evil, and therefore it is a sin to say Germany could learn from Hitler in any way. But just because Hitler did terrible things, it does not mean his economic policies were all bad. So Germany may feel it must do the opposite of what was done under the Weimar Republic and the opposite of Keynesian becomes bad because that is what Hitler did. Writing in the ‘Telegraph’ Ambrose Evans-Pritchard  has made some good arguments on this issue. See: Central bankers should be brought to heel by elected parliaments 

My second point is that the mistake probably made by central banks during the noughties was to take their eye off growth in the broad money supply. In fact if they had watched this more carefully, they may have been more aware of the bubble in their midst.

To an extent central banks are still ignoring broad money, and in Europe especially this may have had disastrous consequences.

Let me finish with this chart. See: Eurozone crisis: It ain’t over yet.
The chart shows quite clearly how much the Eurozone has lagged behind the US and the UK in terms of central bank purchases of securities as a percentage of GDP.

I am not sure that we do need to see an end to the era of central bank independence, but it is time to accept that central banks actually helped to create the credit bubble, and we are still paying for their mistakes today.

PS: In researching this article I stumbled across this by Naridar Singh on the connection between Keynes and Hitler, which I find fascinating.

Here is the key quote:

“In examining Keynes, it would be impossible to overemphasise the significance of the ‘totalitarian connection’. Indeed, Hitler had already found how to cure unemployment before Keynes had finished explaining why it occurred. It was a joke in Germany that Hitler was planning to give employment in straightening the Crooked Lake, painting the Black Forest white and putting down linoleum in the Polish Corridor. With the passage of time, the economic, political and cultural fallout of the Keynes-Hitler sodality has tended only to become more sinister, not less.”

These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees


Showing 1 comment

  1. Garry Hawkins

    Michael,

    Whilst it is true that Central Banks probably kept interest rates too low in the run up to 2007/8, the politicians (via their appointed regulators) could have avoided the financial and banking crises by simply banning the innovative financial weapons of mass destruction at birth (CDO’s, CDS’s and other forms of derivatives) many years before.

    Arguably, it’s these instruments that led to the severity of the crash. Without these instruments, we would have probably ended up with a more classical boom/bust scenario – with a quick recovery from the depths of recession. In other words – more like 1991 than 1931.

    Had interest rates been one or two per cent higher going in to 2007/8, it would merely have delayed recession until 2009/10.

    As it is, in the UK – our bath shaped recession continues until such time the deficit is removed, or at best, very very close to being removed. The longer we leave the deficit in place, the longer it is until we reach the taps at the end of the bath.

    The longer the deficit persists, there’s an increasing likelihood of a sterling crisis and/or a gilts strike by UK sovereign bond holders. And with Sterling lacking the backing of the ECB and 16 Euro states, not to mention no longer being the reserve currency – no one will hear us scream as the debt taps open in the bath and we start to drown in our own debt.

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