The myth of central bank independence

The myth of central bank independence has done its job: depoliticise the economy, insulate elites from scrutiny and block democratic choice — it’s time to bury it once and for all

I’ve written for UnHerd about Trump’s campaign to bend the Fed to his will, the predictably hysterical reaction from the guardians of economic orthodoxy about the “threat to central bank independence” and why the framing of the whole debate is completely flawed: most central banks, including the Fed, are not really independent from government, nor could they technically be; the only real exception is the ECB — which proves why central bank independence is such an insane idea:

The most compelling rebuttal to the panic is also the simplest: the myth of independence was always just that — a myth. As economist James Galbraith noted, the historical record shows that since its inception the Fed has been a creature of the state. Created by Congress in 1913, its powers are granted, limited and revised through legislation. The Humphrey-Hawkins Act of 1978 also subjected it to regular congressional scrutiny. Congress, in other words, has always held the ultimate authority. It appoints the Fed’s leadership and, crucially, has the legal power to mandate policy changes, a threat it wielded in 1982. Former Fed Chair Ben Bernanke himself once conceded that “the Fed will do whatever Congress tells us to do”. The debate thus shouldn’t be about defending a fiction, but about deciding who the Fed should answer to: the executive — as Trump would want — the legislature, or, ideally, the public.

Moreover, on a practical and operational level, central banks cannot be fully independent from the treasury. The functions of the two have to be closely coordinated on a daily basis to ensure that the policy targets of each can be met. They are two wings of the same government body, not separate entities. This is the case in most Western countries: a former Reserve Bank of Australia governor, for example, noted in 1994 that legislation in most democracies allows the elected government to override the central bank. Independence, in other words, was always conditional, a carefully managed illusion. The only real exception is the ECB — a point we will return to.

Central bank independence may be an illusion, then, but it is one that has proved extraordinarily useful for elites. It has been one of the most powerful neoliberal tools to depoliticise unpopular economic actions, such as austerity or high interest rates, allowing elected governments to divert responsibility to “external” agencies, such as budgetary offices, or to “independent” central banks, for policies that they themselves supported but feared selling to the public.

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In any case, even if true independence were possible, it would be profoundly undesirable, since the institution would be wholly unaccountable. Just look at the only major central bank designed to be fully independent of democratic institutions: the European Central Bank. Whereas in currency-issuing nations, the central bank is effectively dependent on government or representative institutions, that relationship switches in the euro area, where governments are dependent on their central bank.

In the wake of the financial crisis, the ECB revealed itself as a brutally political actor. In 2011, it forced Silvio Berlusconi to leave office in favour of the unelected Mario Monti, by effectively engineering a fiscal crisis by discontinuing the central bank’s Italian bond purchases. Then, in 2015, it arbitrarily shut down the Greek banking system to force an elected government to accept austerity.

In short, by adopting the euro, European nations did not merely relinquish control over their monetary policy to a supranational authority — an unprecedented move in monetary history — but they ceded it to an authority with a clear, elite-driven socioeconomic agenda. This underscores the reality of a central bank that is truly independent of democratic mechanisms.

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Thomas Fazi

Website: thomasfazi.net

Twitter: @battleforeurope

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