Politicians are irresponsible enough when it comes to fiscal policy. Giving them total control over monetary policy would be a disaster.
US Federal Reserve Chairman Jerome Powell was recently asked if he would step aside, given that some key players in the incoming Trump Administration want him to go.
His response was unambiguous:
Powell’s clear rejection of being pushed aside is consistent with the law. While Federal Reserve Chairs are appointed by the President of the United States, they operate independently once appointed. There is no mechanism for Powell to be removed just because he displeases members of the incoming US Administration.
Still, that isn’t stopping some from arguing for an end to Fed independence or even an end to the Fed itself:
Note, this isn’t simply criticism of the actions of the Federal Reserve. Criticism of decisions by central banks – like criticism of the Bank of Canada for downplaying the threat of inflation early on – is an essential part of accountability. Central banks have significant power, and a healthy democracy must be able to critique and question powerful institutions to hold them in check.
But there is a big difference between criticizing a central bank and calling for the end of the independence of a central bank.
The latter is disastrous, and here’s why:
Consider how irresponsible politicians already are when it comes to fiscal policy. Political leaders will gladly run up the debt and cause long-term economic damage if they think it will get them re-elected. After all, a debt crisis 20 years from now won’t impact someone who is currently in office.
Politicians without regard for future generations can easily generate short-term economic growth by slashing taxes and ramping up spending, creating a feeling of prosperity and generating economic activity for short-term gain and long-term pain.
We have witnessed this here in Canada, where the Liberal Government chose to extend high federal spending levels following the pandemic, locking in structural deficits and driving up inflation.
Since federal governments have significant control over immense sums of money, there is a massive temptation to use that control to generate economic conditions that make re-election more likely, while leaving the long-term fallout for others to clean up.
Now, imagine how bad things would be if politicians had total control over the money supply.
Governments would be tempted to keep interest rates as low as possible and would want to flood the economy with printed (digitally created) money close to the election.
This is exactly what we have seen throughout history when the independence of central banks is destroyed. Money creation spins out of control, people are robbed of their savings, long-term thinking goes out the window, deficits surge, debt skyrockets, and default often follow.
By contrast, independent central banks often help to lay the groundwork for long-term prosperity.
After the stagflation of the 1970s, the US Federal Reserve under Chairman Paul Volcker took decisive – and difficult – action to stabilize the economy. Interest rates skyrocketed and remained elevated, even as short-term economic pain ensued. Yet, by getting inflation under control, the US Fed – in conjunction with a Reagan Administration that respected central bank independence even as they paid an initial political price for it – managed to lay the groundwork for a US economic boom that lasted from the mid-1980s to the start of the 21st century.
That boom, and the subsequent prosperity that followed, would never have happened without central bank independence. Had politicians controlled the Federal Reserve, interest rates would have been kept low, the value of the US Dollar would have rapidly dwindled, people would have been robbed of their savings, and long-term investments would have crumbled.
This is why institutions matter. Elections often bring about dramatic policy shifts and ideological changes, but those changes are often the result of short-term factors and controversies without much-staying power. Institutions help to maintain stability and guard against extreme changes.
An independent central bank can mitigate the worst excesses of extreme fiscal policies, whether those excesses come from the left or the right. Central banks can also make difficult decisions that are beneficial in the long-run, thus preserving a sense of long-term thinking amid the short-term obsession of most politicians.
This is why we must protect the independence of our core institutions, including central banks. Central bank independence has helped contribute to our prosperity and is an essential check on the power of politicians. That is something we should cherish, not destroy.
Spencer Fernando
Photo – Twitter
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