Independent monetary policy

This is my second article in the line of discussion on, what I refer to as, Crumbling pillars of modern democracy. In my last month article on this subject [1] I showed how the socalled free media may not be so democratic as they want to be perceived and that their monopoly can have long-lasting damaging effect for a democracy. In his recent article on this website, Imagine [2], Z. Pranjic points rightly to another issue that can also be considered a part of this subject, another attack on the pillars of the legislative powers of a state that may well be democratic one, but with potentially forbidding financial costs attached to exercising its power that they may well be forsaken at the detriment of the well-being of its own citizens and possibly of their health too.

The recent heated debate on the possible alternatives for currency for independent Scotland however, overshadowed another, potentially more important but less visible question, that of the apparent lack of any plans for Scottish independent central bank to act as its monetary authority that will regulate financial services in Scotland.

The new style of monetary policies are based on the work of Kenneth Rogoff and his 1985 recommendations for independent, “conservative” central banker who adjusts monetary policy according to the pre-defined rules, usually contractually agreed with the government, and widely published and known to other economic agents. Such policies are in line with the “conservative” bias to tailor the country's monetary policy in line with the needs of their business and investors' community and the market stability.

Although economics analysis can not, without reasonable doubt, show that such independent central banking definitely results in faster economic growth, any foreign investor are likely to be more inclined to invest in countries where they know the government policy and democratic bodies independent central banks will act to protect business interests from politically motivated changes in monetary policy.

Hence, despite public fear campaigns, there is therefore actually a low risk that Bank of England, as an independent central bank following Rogoff's definition, would not act for the benefit of businesses community across the whole Sterling monetary union (or even not unlike European Central Bank (ECB) does for the Euro zone (i.e. despite of its alleged German slant).

Inflation targeting

“[l]ower bank-rates when prices are getting low, and raise them when prices are getting high”- Knut Wicksell’s in “The Influence of the Rate of Interest on Prices” (1912)

One of the main mechanisms central-banks use is inflation control through so called inflation targeting using interest rate as their main tool: increasing interest rates in times of high inflation and reducing it when inflation is relatively low. Many economists [3] claim that, since early 1980s, Volcker-Greenspan interest rate rules have stabilising effect on US economy. Since introduction in New Zealand and Canada, and subsequently in most of industrialised countries, the inflation targeting approach is believed to have greatly contributed to reduction in inflation, in particular the mechanisms based on the interest rate targeting rules pioneered by John B. Taylor in 1993.

Independent Central Bank Efficiency in Deteriorating Democracy

However, not all economists agree with this including the Nobel laureate Joseph Stiglitz who claims that Cental Banks inflation targeting is inefficient whilst other believe that it did not per se bring better and more stable growth as much as just simple belief in its efficiency did.

Following above arguments and arguments of several other academics who analysied and found that central bank's independence is neither the guarantor of, nor well correlated with economic prosperity, one can argue that central bank independence acts more as a business insurance that the financial system of a country will be managed in a manner that is optimally, if not maximally, beneficial for the independent, commercial financial businesses. This often means targeting and controlling inflation, sometimes at the detriment of the real economy, causing recessionary pressure and increased unemployment.

However, the mere notion that a central banks need to be independent rises again, as in case of independent media, the same question of who they are independent from. And again, as some authors [4] argue, the more independent from the government policy the central-banks are, the less power the democratically elected government has over one of traditional state mechanisms, the monetary policy.

What is however less frequently publicised, such independent central banking is in part designed as a protection against politically motivated use of monetary policy by the governments, especially in pre-election periods when a government can create a temporary image of a better economy by reducing interest rate.

However, removing this power from hands of democratically elected government and parliament did not prevent power being used or misused. It just changed its hands: a body protecting interest of business now has that power to reduce or increase interest rate in pre-election periods and so increase or reduce chances of incumbent administration to be re-elected again.

The US Federal reserve was, for example, criticized by the very author of the inflation targeting rule, John Taylor, for departing from his rule and keeping the policy interest rate far too low in period of late 2003 and early 2004, boosting cheap sub-prime mortgages and, hence becoming a contributing factor to the build-up of he sub-prime mortgage financial crisis of 2008. One however, may then also ask if keeping the rate too low could have been, at least in pat, also politically motivated, so to improve the chances of the then incumbent president, G.W. Bush, to win his re-election in November 2004.

But what it then also translates into is that democratically elected bodies of government or parliament have been denied the right to take direct control of one of the pillars of the public policy – the monetary policy – and have been restricted to control the fiscal policies and the budgets for various public services only.

That is, for the sake of support of liberal, commercial, media and financial institutions, democratically elected politicians have, so far, relinquished the governments and democratic states they serve of their traditional power over monetary policies and weakened the democracy even if perfectly democratic electoral mechanism is in place.

We do not need to go far to find examples so, lets take a look at the not so distant, recent UK history. Before Labour party was (or possibly could be) elected in power in 1996, it gained full public endorsement and support of the commercial media moguls such as Murdock. But this, at least apparently, was not before they committed publicly to giving much higher levels of independence and powers over monetary policy away to Bank of England. What appears is that such move gained them support of both the business and the financial industry and, consequently, the media. They however separated from the new BoE and retained direct state control only over the financial service overseeing authority – FSA.

Hence, despite making such policy public prior to the elections and then claiming full legitimacy to follow-it up afterwards, one can, nevertheless, still question full legality of their action of giving-up monetary policy away from control of democratic government to an independent, non-elected body and one may argue that it may verge with a crime against their own sovereign state and their democratic electorate.

Later on, before they were elected, the Conservatives announced that they will split FSA and join one of its parts back to BoE, a policy which again gained them support of financial industry and media and which they implemented after their consecutive election. Therefore, before they could be elected, Conservatives themselves effectively had to announce that they will gave away even more of the democratic government's powers and responsibilities to an unelected body, giving away therefore even further regulative powers of a democratic state to unelected bodies designed to protect financial industry.[5]

Ironically, it is in part for the above reasons that Mr Salmond could confidently maintain his promise that the future currency union with RoUK and the joint monetary policy lead by BoE would still keep Scotland away from the influence of Whitehall.

Epilogue: It may hence come as no surprise – though it was for me - to read the latest news while writing the above text, that, at last, there are strong moves by some democratically elected politicians to take more control over the central banking and monetary policy. It may be the biggest surprise that these moves do not come from some socialist government of old Europe but from none else then the Republican US congressmen who are pressing for legislation that will give the Congressmen powers to scrutinise and audit work of the US Federal Reserve bank as the US central bank is known. These recent rumours have already created a panic among many of economists from both Keynesian and liberal orientations.

[1] The balancing of the scales - http://wsimag.com/economy-and-politics/13150-the-balancing-of-the-scales
[2] http://wsimag.com/economy-and-politics/13577-imagine
[3] e.g. Clarida, Gali and Gertler (2000)
[4] Goodman, John: The Politics of Central Bank Indepdence, Comparative Politics, Vol. 23, No. 3 (Apr., 1991), pp. 329-349
[5] To gain full media support, they also promissed furthre derelgulation of media industry in favour of Murdoch's media corporation but consequently renegaded midst the News of the World hacking scandal.