On 23 October 2008, the former Federal Reserve Chairman Alan Greenspan appeared before the Congressional Committee and admitted that ‘flaws’ in his worldview had blinded him to the largest private debt bubble the world has ever seen. It was a startling admission that free market ideology, not objective ‘science’, had been guiding US monetary policy for the previous twenty years. The once incontrovertible notion of central bank independence, with its hawk-eyed prioritisation of price stability, suddenly looked vulnerable.
In the ten years since, as central banks have deployed considerable firepower to kickstart an anaemic recovery, the questions around central bank independence have only continued to mount. In the absence of excessive (or indeed any) inflation in most advanced economies, and with monetary policy requiring more and more help from the fiscal side, central bank independence seems both less necessary and less practical. Meanwhile, enhanced powers granted in the wake of the crisis raise serious democratic concerns, particularly regarding the uncertain and potentially political consequences of unconventional policies.
The time is therefore ripe to rethink the relationship between the state and the central bank. But the powers that be do not agree. “Credibility hinges on independence,” announced European Central Bank (ECB) President Mario Draghi in a recent speech, repeating familiar arguments for keeping central banks separate from the political sphere. This narrative emerged relatively recently as part of the monetarist reaction to the stagflation of the 1970s, when policymakers were perceived to have a bias towards inflationary policies due to temptations to ‘cheat the system’ for short-term political gain. To contain inflationary dangers, central bank mandates were restricted to the management of price stability, and operational independence was granted to set monetary policy free from government interference.
