I suppose I am not the first person to suggest that all intellectuals have a secret desire to be philosopher kings. “If only the world’s policymakers would do what I want, things would be much better.” At times intellectuals are seduced by authoritarians who seem to adopt sensible economic policies, people like Lee Kuan Yew of Singapore. But for every Lee, there are a dozen Saddam Husseins, Kim Jong Ils and Turkmenbashis.
After the Great Inflation of 1966-81, economists developed all sorts of ad hoc models proving that democratic governments are biased toward excess inflation. Unfortunately, the models were discredited almost as soon as they were published, as inflation rates plummeted almost everywhere. But they did have an impact on the thinking of economists. Many economists (and I am ashamed to admit that I was one of them) began to think “If only we could have a central bank that was shielded from political pressure. If only monetary policy could be run by philosopher kings.” As we will see, those sorts of Faustian bargains often backfire in the long run. One should never support a political process reform because one thinks it will lead to a particular policy outcome that you favor.
Of course whenever economists decide they think a policy is wise, they find empirical studies that “scientifically” prove the validity of those policy prejudices. And sure enough, we soon began to see studies proving that independent central banks produce lower inflation rates. I’m not suggesting those studies are completely wrong, but in retrospect it seems like central bank independence is much less important than the intellectual zeitgeist. Inflation fell everywhere after 1982, regardless of whether the country had an independent central bank.
In retrospect, the subsequent move toward greater central bank independence appears to have done more harm than good. The three major examples of greater central bank independence were the Bank of England, the Bank of Japan, and the ECB (which obviously is a special case that combines two features.)
Making the BOE independent doesn’t seem to have had much effect on British monetary policy. The ECB is more complicated. Obviously the so-called PIIGS are suffering partly due to their lack of ability to depreciate their currencies (although monetary policy is certainly not the only problem they face.) On the other hand the ECB actually represents two changes at once—movement away from the ability to conduct domestic monetary policies, and the movement toward a more independent central bank. Indeed the ECB may be most independent central bank in the world, given its insulation from influence by any single government.
But the best example of the folly of making a central bank independent comes from Japan. I am not going to argue that the 1997 decision to make the BOJ independent caused the subsequent deflation–as we saw the BOE avoided deflationary policies after becoming independent—but it certainly prevented successive Japanese governments from being able to easily fix the problem.
TOKYO—The Bank of Japan faces new political pressure to move more aggressively against deflation, as Japanese lawmakers set the economic policy agenda following the ruling party’s crushing election defeat.
Your Party, a powerful new force in the parliament after Sunday’s elections, and a potential policy partner for embattled Prime Minister Naoto Kan, is planning to turn up the heat on the central bank to reverse a decade of declining consumer prices that has sapped the economy.Yoshimi Watanabe, president of Your Party, speaks about the yen, postal bills and the future of his party in an interview with The Wall Street Journal.
In an interview Wednesday, Your Party chief Yoshimi Watanabe discussed his plans to require the BOJ to play a more active role in boosting the economy, including setting an inflation target taking responsibility if it fails to deliver results. That responsibility could come either through more frequent testimony in parliament, or possibly by forced changes in leadership.
The central bank should also take into account the impact on the yen’s exchange rate when it sets its policy, the lawmaker added.
“Insufficient monetary easing has been simply the only reason why Japan hasn’t been able to conquer its deflationary gap,” Mr. Watanabe said. “Thus, the government and the Bank of Japan should form an accord and share a price-stability target.”
Mr. Watanabe is just the latest Japanese political leader to challenge the BOJ’s independence. Policy makers long have been frustrated with what they consider the central bank’s insufficient concern for deflation.
The Japanese government’s only tool for boosting AD was deficit spending, and as they quickly learned (and we are now discovering) fighting tight money with fiscal stimulus is like attacking Sherman tank with a bow and arrow.
Of course the political independence of the Fed is one of the root causes of our current fiscal follies. If Obama controlled the Fed he could quickly boost AD, which would allow him to rapidly shrink the deficit. (Well, at least he could do this if he understood the importance of monetary policy, which is not at all certain.)
PS. For newer readers I should explain that although I like Singapore’s fiscal regime, I don’t like their political system. Instead I prefer the least philosopher king-like system on earth, Switzerland’s hyper-democracy.
PPS. Japan’s new political party entitled “Your Party” reminds me that the US needs new political parties with more interesting names. ‘Democrat’ and ‘Republican’ both sound so boring. What about Thailand’s “Thais Love Thais” party? (Don’t we all love Thais?) Or Italy’s “Let’s Go, Italy.” (After all, politics is a spectator sport.) Or Iceland’s “The Best Party.” (Don’t we all want to vote for the best party? Especially one that produces this sort of campaign commercial?)