Central Banks Should Listen to Politicians

MORE central banks are being given greater independence from their nation's political masters.

The central banks of Chile, Sweden, the Czech Republic, Hungary, France, Mexico, New Zealand, and Venezuela have all had their independence enhanced. The Maastricht Treaty requires national central banks participating in the European System of Central Banks to meet a prescribed standard of independence. In Britain, proposed legislation would make the Bank of England, now explicitly subservient to the Treasury, independent. The Bank of Canada has been trying to get a more specific mandate from the government as to its responsibilities.

Governments assume that greater independence will improve the performance of central banks in fighting inflation. Academic studies find that to be the case, at least in the industrial nations.

It adds up to what Guy Debelle, an Australian graduate student at the Massachusetts Institute of Technology's department of economics, and one of his professors, Stanley Fischer, describe as a ``new orthodoxy.'' But in a paper given at a Federal Reserve Bank of Boston conference this week, the two suggest that independence can go too far.

In general, central bankers would rather not have politicians telling them how to manage monetary policy.

Fortunately for them, most politicians want to duck the responsibility of deciding monetary policy. For one thing, determining the correct degree of tightness or looseness for credit is a difficult, time-consuming task. Congress, which has the constitutional responsibility for monetary policy, set up the Federal Reserve system with its economists and financial experts to carry out that duty.

Second, legislators don't want to be blamed if a stern anti-inflationary monetary policy raises interest rates, causes a recession, and expands unemployment and business failures. They find it more palatable to tell voters: ``It's the Fed's fault.''

The electorate doesn't always buy that plea. Many voters blamed President Bush for a slack economy in the 1992 election, probably costing him his job. Today, President Clinton is claiming credit for a more vigorous job market, though most economists would say that an easy monetary policy has much to do with it.

Some political scientists will argue that if the president gets the blame or credit for the impact of monetary policy on the economy, he should have control over policy. Fed officials, conscious of their ultimate political vulnerability, do not relish political clashes with either the president or Congress. So the Fed's institutional independence is tempered by the political climate.

When Fed chairman Alan Greenspan testified Wednesday before the House Budget Committee, he was polite and deferential. The Fed's autonomy (shown, for example, in 14-year terms for Fed governors) meant that, if asked, Mr. Greenspan would have refused to give the date and amount of the next change in interest rates. But Greenspan also was politically accountable, required by law to appear and face questions as to the economy and Fed policy. Though free to answer in a Delphic manner, wise Fed chairmen listen to the political winds.

To Messrs. Debelle and Fischer, Germany's Bundesbank, famous for keeping inflation low in Germany, is too free, not sufficiently accountable to the politicians. Its policymakers do give press conferences, but they do not need to justify their actions to the legislators in Bonn.

``All institutions need to be held accountable for their actions or their performance suffers,'' the two economists maintain. They add that the ``cult'' of central bank independence, the appointment of independent central bankers, and the heavy emphasis on countering inflation, seem to lead to ``an excessive concentration on inflation prevention, and insufficient acknowledgment of the short-run trade-offs between inflation and output.''

If central bankers don't face some accountability pressures from politicians, they ``run a very good chance of becoming too conservative,'' the economists say. In fighting inflation, they may create more unemployment than is desirable. Germany's last two recessions were worse than those in the United States.

Debelle and Fischer would like the Fed to be given a less ``fuzzy'' mandate as to its goals for inflation and output. The Bundesbank needs more political feedback, they say.