Matthew Lynn: the era of central bank independence is over

In his MarketWatch column, Matthew Lynn presents a case for why the era of central bank independence is coming to an end.

He cites a variety of factors like how quantitative easing redistributes wealth or how zero interest rate policies punishes savers.

What he leaves off the table is the elephant in the room.  The justification for central bank independence was that it was needed so they could take away the punch bowl and keep the financial system from collapsing.  The central banks in the EU, UK and US all failed to take away the punch bowl that let the financial sector get out of control leading up to the current financial crisis.

When you are independent and don't do your job, you lose the right to this independence.

for the last decade there has been one principle that everyone has agreed on. Independent central banks free of political interference are a good thing. 

But now that is under attack everywhere. 

Increasingly it looks like the model of the independent, technocratic central bank is on the way out — and will be replaced by direct control of monetary policy by governments. And that will change the rules of the game for investors. 

Central bankers used to be grey, colorless figures. ...

Now they are in the thick of the day-to-day political battle....

The days when central bankers were above the political fray are long gone. It is not hard to figure out why. 

First, the game has changed. The main intellectual argument for independent central banks was that they could make long-term decisions without short-term politics getting in the way. They would have more credibility with the markets when they set inflation targets, because investors would know they wouldn’t get blown off course by the need to pump the economy up and get incomes rising ahead of an election. 

That doesn’t seem so important anymore. Central bankers aren’t fighting inflation — there is not much sign of it — and recession is their main enemy. They don’t have that much credibility either: very few investors believe something is going to happen just because the Fed or the ECB say it will. 

And the assumption that there are simple mechanical choices to make — slightly slower growth this year, for example, in exchange for healthier long-term expansion — no longer seems to apply. 

The result? There isn’t any reason to suppose that an independent central banker will do a better job than an elected politician. 

Second, central bankers are now acting like politicians anyway. They always have to some extent, of course. But it has become more obvious. 

Take quantitative easing, for example. It redistributes wealth. It punishes savers and rewards debtors. It permits a far-larger state than would otherwise be possible — although at the expense of future generations who will have to pick up the bill for current spending. 

Or take near-zero interest rates. They help younger people who are trying to buy their first home. But they punish older people who are getting far-lower pensions from their savings than they could have expected. They are all choices about who gets what, and who picks up the bill. 

You can agree or disagree with them; there are perfectly respectable arguments to be made on both sides of the issue. But they are political choices, of the sort that used to be settled by politicians and involve elections. When they are making those kind of choices on behalf of society, central bankers have to expect to get drawn into the public debate.

But central bankers are going to struggle in that role. There are two big problems. First, they have no mandate. They are chosen from within a narrow pool of career bankers and officials. They don’t have the legitimacy that comes from having won an election, and that makes them easy to attack. Next, none of them know the language to defend their decisions. They have no training in oratory, nor do they know how to win support for their decisions. Again, they are an easy target.

I disagree with his two reasons for why central bankers struggle.

First, central bankers adopt policies that support the policies of the elected officials.  It was the elected officials who chose to pursue the Japanese Model for handling a bank solvency led financial crisis.

As a result, the central banks have adopted policies designed to protect bank book capital levels and banker bonuses at all costs.  Even if this means destroying the financial markets, the real economy and the social contract.

Second, central bankers are trained to verbally defend their decisions.  For most of them, this training came in the oral defense of their PhD dissertations in economics.

By the end of the decade, it is unlikely any central banks will still be independent. 

Instead, governments will take direct control of monetary policy. 

The U.K. may well go first. It was only in 1997 that the Bank of England became independent. Until then, interest rates were set by the government. Europe will be next. The ECB president is already running half the continent. The Fed may hang on longer. Americans are historically reluctant to give their government any more power. But it will be put under tighter political control.