In most western countries, central banks are, at least in theory, wholly divorced from the political process. Central bankers are selected to terms far longer than that of the average politician—and they are typically allowed to oversee numerous changes in political leadership during their time at the helm—in order to insulate them from the rough and tumble of everyday politics. In theory anyway, the central bank concerns itself purely with inflation rates and monetary policy; fiscal policy, tax rates, and other such matter are left up to the politicians.At the end of the day, this is about the long term sustainability of a fiat money system. If monetary authorities get into the habit of excessively manipulating the money supply, a fiat money system gradually loses credibility. That loss of credibility was a factor in the inflationary wave of the 1970s, and the greater move toward political independence for central bankers was part of the response.But what if the recent long-term financial crises are chipping away at central banks’ cherished political independence? The BIS (aka the Bank For International Settlements—the bank of banks) seems to think this is happening. In an interview with the Wall Street Journal, the BIS’s Stephen Cecchetti worried that central banks are becoming too politicized:
Mr. Cecchetti echoed those concerns. Central bankers “have been made the policymakers of last resort,” he said. “That’s not where they should be. They can’t implement structural reforms, they cannot put fiscal policy on a sustainable path. This reliance on the central bank makes it so the other actors…get to wait a little bit” in implementing reforms, he said.
The real worry is that the unconventional measures like quantitative easing that central banks have been using are politically motivated. To put it another way, there is so much pressure on central banks to keep the world economy from collapsing, that the banks have lost all autonomy over their policy. Instead of performing an independent function in economic policy, central bankers have blackmailed by politicians who refuse to take politically costly measures to stabilize the economy. Central bankers are faced with an impossible dilemma: do they let the economy and the financial system collapse, or do they take steps to insulate the economy (and the politicians) from the consequences of poor leadership?The timidity of politicians has forced central bankers into a role that was never intended for them; central bankers today are now the de facto drivers of monetary and fiscal policy, yet, being bankers rather than elected leaders, they lack the needed tools to put their country’s finances on a firmer footing. Untested and increasingly ineffective programs like QE I and II have been the result.If Cecchetti is right, the entire basis of economic and monetary management in the contemporary world is even worse than the grim headlines from Europe lead us to believe. We may not just be facing a crisis of confidence in the governance structures of the eurozone; we may be facing a crisis of confidence in the ability of modern industrial societies to manage a fiat money system.