Friday, November 20, 2009

Barbarians at the Gate: Are We Watching the Demise of Sound Central Banking?

Bob McTeer explains in this post and John Taylor in this post how central bank independence to conduct monetary policy is under attack here in the US. It's also under attack in many other countries right at this moment. Take the Central Bank of Brazil, (which has never been too independent anyway) as an example: it has been steadily losing its small share of decision power to the Brazilian Ministry of Finance, a process that started years ago but has picked up steam lately.

The reasons for this trend have much more to do with public choice than monetary economics. What most central bankers may have forgotten, even in the Fed, is that central bank independence is a daily battle, not granted by divine intervention, and that it'll never be really written in stone, no matter how strong is the legal framework supporting it. In policy making, public choice trumps monetary economics always. That's the reason why my article on monetary policy is titled "Canaries and Vultures": canaries always trump vultures in politics. That's the reason why we created independent central banks in the past.

Here are my two cents: central bankers accepted to make what they thought would be a short lived but necessary pact with the devil: we abandon some of the most sacred and sound monetary principles of central banking to temporarily avoid some of the harsh consequences of the financial crisis (more details in this post). The political calculation however was a Titanic error: they irreversibly opened the gate of the fortress to the barbarian invasion. Central banks lost the higher moral ground, and every time they do it, they pay dearly.

Talking clearly about the foundations of central banking, as McTeer does in his posts, helps to avoid the worst, but I'm really pessimistic regarding the prospects of a rational economic debate on central banking here and in other nations for the time being. Short-sighted political calculation will not go away before we rediscover the need to strengthen central bank monetary policy independence. This is probably not going to happen before inflation sets in again.

Call this imbroglio one of the unintended consequences of the policies adopted since the beginning of the crisis, as I suggested in this comment to another McTeer post.

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