The independence of central banks

Last week, the world witnessed yet another unusual scene among the many that Trump presidencies provide. Side by side, with construction helmets on their heads, the President of the United States and the chairman of the Federal Reserve Bank of America interrupted a visit to the construction site of the new Federal Reserve headquarters in Washington to speak to reporters. There's no need to describe the rest of the scene everyone witnessed. With Trump, these occasions are more than just public displays of a political leader's idiosyncrasies. They are recurring rehearsals for a way of communicating with the electorate that resembles as closely as possible the imagery and tension of a reality show in which one of the participants—Trump himself—is the ever-prominent, ever-dominant, ever-indispensable character.

In this particular case, Trump intended to publicly destroy Powell's reputation. It was yet another of his countless attempts to do so. After his attempts to fire Powell were thwarted by the US Supreme Court, Trump now intends, if not to force him to resign due to unbearable political pressure, to at least tarnish his reputation, ensuring that the next Federal Reserve chairman will be more docile to the White House's will, which in the current context means lowering interest rates. Next Wednesday, we'll see what the Federal Reserve decides to do. I have no doubt that, in this juncture, the US economy is better protected if monetary policy is not driven by Trump's enervations. Nor do I doubt that Powell successfully achieved the soft landing of the US economy after the recent inflationary surge that many predicted was impossible.

However, the underlying problem is not new and is far from resolved. That is, should central banks make monetary policy decisions completely independently? If so, to what extent does this independence extend? How can the criteria that support central bank decisions be reviewed? Excluding the banking supervision function, when this falls to central banks, it is no minor decision to remove from the executive's political will a function traditionally associated with sovereignty itself, such as monetary policy, as it seeks to determine the volume of the money supply, interest rates, and the national exchange rate. If, in Portugal, these issues are not pressing, it is because a near-consensual sovereign decision was made to "share" national sovereignty with other national sovereignties within the context of the European Union and, more specifically, the Economic and Monetary Union. In other words, the Portuguese decision on central bank "independence" was made under a broader decision on national sovereignty. Hence, it would be ignorant folly or an exercise in bad faith to make the context of appointments to the governor of the Bank of Portugal equivalent before and after our accession to the Eurosystem.

Paradoxically, it was democratic states based on a more or less confused form of popular sovereignty that most frequently chose to grant central banks independent status. This was not due to historical inertia, since independence, and even the private nature of monetary policy decisions during the era of central banks' initial rise, were initially replaced by relations of subordination of these institutions to the executive branch. When the idea of the goodness of institutional independence finally triumphed in Europe and the US, it was for reasons stemming from both the study of political economy and the theory of organizations and institutions. The American "independenceist" thesis accounted for superior performance in price stability and the very progress of the economy if central bankers were immune to the spasmodic gestures of politicians, creatures always chasing the irrational whims of voters. The more sophisticated German “independenceist” thesis sought to place price stability and institutional independence as one of the fundamental precepts of an economic constitution of freedom parallel to the political constitution itself – in both a certain conception of the separation of powers would reign.

But the merits of these theses do not obscure the nature of the underlying problem. Monetary policy is a form of politics and involves fundamental considerations of articulating the common good of a society. This means that the "sovereign" central bank exercises concrete political power, in one of its many manifestations. Furthermore, even the ECB's relentlessly Germanic statutes admit that monetary policy must be coordinated with other forms of economic policy, such as fiscal policy, which would seem to indicate that the desired cooperation calls for explicit political coordination.

In reality, there has always been a certain tension between, on the one hand, the logic of the separation of powers, with its most peculiar corollary—the independence of the judiciary—and, on the other, the imperative of coordinating political wills in the service of a political project or the naive achievement of the common good. Judges, who initially wanted freedom from the power of the centralizing king, quickly realized that, in the democratic era, their independence was equally vital for the proper and impartial enforcement of the law, and thus for the realization of a just society. However, when the idea of separation of powers spread to the concept and reality of the regulatory state, itself a product of the extraordinary concentration of tasks that the state has accumulated for itself, it was the seduction of judicial independence that infected the establishment of regulatory independence. And if judicial independence prevailed even when the judge was demonstrably also a co-legislator, and not just a mechanical mouth that delivered the sentence foreseen by the legislator, the regulator and the central banker were also able to claim independence despite having become judges and legislators.

It turns out that this assumption of power and its respective exercise are not accompanied by subjection to public rebuke or criticism. The public voice addressed to it is interpreted as illegitimate and conditioning pressure, only tolerable given the priority of freedom of expression in democratic societies, but without a political function per se. In this regard, the tension redoubles in a way that an example can illustrate well. Alan Blinder, Vice-Chairman of the Federal Reserve in the 1990s, once said on a television program that "the last duty of a central bank governor is to tell the public the truth." Here, the monetary authority finds the ultimate justification for its "independence" in the formation of truth and its communication to the "public." It consciously acquires a public political function that is not to be confused with technical specializations in the art of administration. With what purpose? To mobilize public opinion, evidently; the same opinion from which the monetary authority was initially removed and to which it demands to remain aloof.