Factbox: What is central bank independence?

Talks of a change in the powers of the Bank of England have revived a debate about whether central banks should be independent of governments and in what way.

Central bankers are tasked with preserving the value of the currency by keeping inflation under control. For this purpose many of them are saved from political pressure from governments.

Once a sacred cow in the Western world, this freedom has been called into question more often in recent years as central banks stepped in to bolster governments when they were hit by the global financial crisis and then the coronavirus pandemic.

Reuters cited here are some questions and answers about a topic that is rapidly spreading from academia to the political sphere and could have a profound effect on inflation over the next decades.

What happened?

Leading to become Britain’s next prime minister, Liz Truss has promised to review Bank of England remittances – potentially including the ability to free interest rates from government interference.

It comes after the UK central bank on Thursday raised rates to the highest since 1995, while also predicting a protracted recession and double-digit inflation – a double whammy for domestic finance.

BoE Governor Andrew Bailey is not alone. Central bankers around the world are criticizing politicians for failing to predict and prevent the current bout of high inflation.

What is central bank independence and why does it matter?

A central bank is independent if it can make policy, such as setting interest rates or printing money, without interference from elected officials or the private sector.

The idea is that governments will resort to the central bank when they need re-election and prevent rate hikes that would be too painful for their voters.

This causes the economy to overheat and drive inflation too high until the inevitable bust.

Instead, central bankers should focus solely on inflation, sometimes married with another goal such as full employment, and let politicians tackle questions of redistribution and fairness.

Does it work?

Data shows that central banks such as Germany, Austria and Switzerland achieved less inflation between 1970 and 1999 than those with close ties to their governments, for example in Norway, New Zealand and Spain.

But this relationship weakened in the new millennium as new forces came into play, such as greater globalization and the introduction of the euro.

The options, however, are hard to stomach.

In Argentina, where the central bank is firmly under the control of the president, inflation is close to triple digits, with the peso losing half its value in less than 1-1/2 years and allowing citizens to buy foreign currency or sell goods. to face sanctions. abroad.

Are most central banks independent?

Most central banks in the developed world and emerging economies are formally independent, albeit to many different degrees.

In practice, the line between central banks and governments can be blurry and in some cases is little more than a humble imagination.

Turkey’s central bank is formally independent, but that hasn’t stopped the country’s president, Tayyip Erdogan, from sacking governor after governor if he doesn’t fulfill his wishes.

Even in the United States and Europe, central bankers are routinely accused of bankrolling states with huge purchases of government debt, which has become common since the global financial crisis.

While these ‘quantitative easing’ programs are always justified with the need to boost inflation, when it is too low, they allow central bankers to work side by side with their governments rather than side by side. Huh.

Nowhere was this more visible than in Japan, where the central bank owns half of the government’s debt.

Has central bank independence always been the norm?

No, the central bank was a branch of the government until recently.

The idea of ​​a fully independent central bank was discussed in 1962 by economist Milton Friedman, who rejected it on the grounds that it would not survive the first “real conflict” with the government.

The Federal Reserve has enjoyed operational independence since 1951 but presidential intervention lasted at least the 1970s.

Then-Fed Chairman Arthur Burns was under pressure to keep policy easy to help US President Richard Nixon win re-election.

The ensuing, decade-long battle of high inflation triggered by an oil shock to be adjusted by Burns’ Fed fuelled the idea of ​​central bank independence.

It gained currency in the 1980s and began in the 1990s, when several central banks, including the Bank of England, were reformed and more were created as the Eastern Bloc.

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