Central bank independence in a democracy: narrower the mandate easier to defend it..

Jens Weidmann of Bundesbank is one of those central bankers whose speeches are quite interesting to read. The last one was connecting beatles to central banking.

In a new speech, he looks at several things but this one caught my eye:

Central bank independence in a democracy

Ladies and gentlemen,

From the vantage point of politics, the central bank as “crisis response unit” has clear advantages. First, central banks allegedly have powerful tools and deep pockets. And second, central banks decide independently and can act quickly, which saves governments from organising parliamentary majorities for unpopular decisions.

However, if unelected technocrats like independent central bankers take such important decisions, the question can be raised of how to square this with democratic principles. And indeed, if certain conditions were not met, independence would become hard to justify, in my view.

One condition is that central bankers explain their policies to the public. As Alan Blinder, whom I just mentioned, put it: “(-) public accountability is a moral corollary of central bank independence. In a democratic society, the central bank’s freedom to act implies an obligation to explain itself to the public. Thus independence and accountability are symbiotic, not conflicting.”11 

A second condition that needs to be met in order to make central bank independence compatible with democracy is a narrow interpretation of the mandate. It’s true what the NGO “Transparency International” wrote in a report on the ECB: “If independence is one side of the coin, the flipside is a narrow mandate.”12

And indeed, if independence is used for purposes other than those given by the mandate, we shouldn’t be surprised if the central bank is increasingly put under scrutiny. Acting beyond the mandate would also undermine people’s trust in the central bank.

This makes a lot of sense. RBI for instance is always under some form of attack as it has such a wide mandate.

Lots more in the speech on history of inflation and central banking, time-consistency, ECB, Bundesbank, financial literacy and so on.

In the end several quotes:

Nelson Mandela wrote in his autobiography “Long Walk to Freedom”: “I have discovered the secret that after climbing a great hill, one only finds that there are many more hills to climb.”

Central banks all over the world were forced to climb great hills over the last decade. And there are more hills on the horizon. But central banks should beware of overburdening.19  We are not superheroes. Indeed, our powers are limited. Neither can we compensate the adverse effects of demographic changes nor can we hasten the invention and adaption of new technologies. We cannot lift long-term growth. And we cannot erase inequality. 

Wim Duisenberg, the first President of the ECB, once said: “Don’t ask for monetary policy to perform tricks it cannot deliver.” Too much power undermines support for central bank independence. 

Even fictional superheroes have drawn criticism when their feats involved considerable side-effects. In the movie “Captain America: Civil War”, the first film featuring the Black Panther, the United Nations created the Sokovia Accords in order to regulate the activities of the Avengers.

In order to defend their independence, central banks should interpret their mandates narrowly and seek the support of the broad public. People’s trust gives us scope to take decisions that are not always popular in the short run. 

Two years ago, Janet Yellen, the former Chair of the Fed, told a congressional hearing something very important. She said: “Sometimes central banks need to do things that are not immediately popular for the health of the economy.”20  Indeed, it’s not our job to be everybody’s darling. This gives us all the more reason to continuously explain to the people, in a comprehensible way, why our work is nevertheless beneficial for society. 

Nice stuff as always from Dr. Weidmann..

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