Monday, November 22, 2010

Down that road lies Zimbabwe

It is said that the road to hell is paved with good intentions. Little by little, I see that the independence of central banks is waning. The Buttonwood blog at The Economist recently commented:
I get the feeling that we are approaching the end of an era. Independent central banks appeared to solve the problem of defeating inflation, but there was always a democratic issue. We have now reached the stage when central banks are being asked to do things that politicians know that the electrorate would not be willing to support, a trend that arguably goes back to the Mexican bailout of the mid-1990s. It does not seem sustainable.

The Federal Reserve, after facing much criticism of its QE2 program, has had to take the unusual step of publicly defending itself.

Across the pond, Bundesbank president Max Weber warned six months ago that the ECB is eroding "its independence by financing debt-strapped nations and keeping banks on life support as Europe’s debt crisis persists." Now those warnings of those risks may be materializing as beyond Ireland lie the other periphery eurozone countries.

A counterweight to fiscal policy
One of the roles of monetary policy played by central banks is to act as a counterweight to fiscal policy, which tends to be more politically driven. While I have expressed my own concerns about the effectiveness of QE2 and I do believe that the Fed's operations are overly opaque and audits may be beneficial, I would nevertheless support the principle of central bank independence.

If central bankers were to come under the power of politicians, then monetary policy can no longer be the counterweight to fiscal policy. Down that road is economic instability, banana republics and Zimbabwe.

No comments: