Central Banks in the Age of Populism

Yves here. I am sure quite a few readers will find this wrap of economists’ views on political pressures on central banks to be frustrating. There is no acknowledgment of the fact that central bankers at best are cognitively captured by financiers, as a central banker, Willem Buiter, pointed out to much outrage at the 2007 Jackson Hole confab.

Similarly, central banking is now dominated by monetary economists…even though monetarism was decisively shown not to work in practice in experiments run in the Thatcher and Reagan eras.

But most important is that central banks have come to see limiting inflation as a more important part of their job than promoting, or at least not getting in the way of, growth. They have also become unduly active in managing the prices of financial assets (look at the Bank of Japan buying stocks, and the increasingly mainstream belief among US money managers that the Fed intervenes in equity markets). The long-standing Greenspan, then Bernanke, then Yellen put, with central banks around the world embracing similar policies, means the risk of investing in financial assets has been reduced. That results in overinvestment in them and resulting overfinancialization of the economy. We’ve also pointed out that in recent years, more and more studies have found that an overly large banking sector is a negative for growth. Yet central bankers seem mystified that the broad public is more and more unhappy with them.

By Silvia Merler, an Affiliate Fellow at Bruegel. Prior to that, she worked as Economic Analyst in DG Economic and Financial Affairs of the European Commission. Originally published at Bruegel

Two years of elections have shown that we live in an age of increasing political and economic populism. What are the consequences of that for central banks? We explore opinions about it, from both 2017 and more recently.

Charles Goodhart and Rosa Lastra have a new paper out as well as a VoxEU piece on the subject. They argue that the consensus that surrounded the granting of central bank independence in the pursuit of a price-stability-oriented monetary policy has been challenged in the aftermath of the global financial crisis, in the light of the rise of populism on the one hand and the expanded mandates of central banks on the other hand.

After considering the economic case for independence as well as the existence of distributional, directional and duration effects, the paper examines different dimensions in the debate of how the rise in populism – or simply general discontent with the status quo – affects central bank independence. While it is possible – but uncertain – that monetary policy may continue to be independently operated, Goodhart and Lastra argue that there is a possibility that the blurring of independence in the field of financial stability may also raise questions for central banks’ independence more broadly. It is therefore important to have in place adequate mechanisms to ‘guard the guardians’ of monetary and financial stability.

Dani Rodrik writes that while populism in the political domain is almost always harmful, economic populism can sometimes be justified – for example, when it questions the excessive focus of independent central banks on keeping inflation low. Part of today’s populist backlash is rooted in the belief, not entirely unjustified, that delegation to autonomous agencies or signing on to global rules does not serve society, but only a narrow caste of “insiders”. Independent central banks played a critical role in bringing inflation down in the 1980s and 1990s. But in the current low-inflation environment, their exclusive focus on price stability imparts a deflationary bias to economic policy and is in tension with employment generation and growth. Rodrik argues that in such cases, relaxing the constraints on economic policy and returning policy-making autonomy to elected governments may well be desirable.

Douglas J. Elliott from Oliver Wyman highlights some key assumptions of recent decades that may be reversed if we have enter a populist era (Figure below). He believes that financial institutions need to think today about whether they could adapt as necessary. Actions should be taken to re-evaluate strategic planning and stress testing processes to ensure that potential outcomes are not implicitly or explicitly dismissed as impossible. Beyond that, the potential for changes in the environment this large should be a further spur to redesigning firms to be more agile and to clear away the obstacles to good governance, sound data management, optimal financial resource management, and other key tools that will be even more clearly necessary for success.

Lucrezia Reichlin argued last year that with populist movements gaining ground, their complaints about independent monetary policymakers could now change the relationship between central banks, treasuries, and legislatures. The diverse range of critiques against central banks come from both the left and the right, and some overlap with concerns voiced by conservative economists that central banks have assumed an excessive role in managing the economy since the 2008 financial crisis. But whereas populists tend to favour limiting central banks’ political and operational independence and broadening their mandate, conservative economists want the opposite.

Reichlin thinks that populist solutions may be ill-advised, but the problems populists have identified with respect to central banks are real. If we believe that central banks should be protected from short-term political interference as they pursue monetary-policy objectives, it behoves us to implement reforms that will allow for democratically accountable coordination among monetary, fiscal, and financial authorities.

Jacqueline Best argues that politics should be brought back to monetary policy. Although technocratic exceptionalism is tempting, especially in the face of the threat of illiberal democracy, it is also quite dangerous, since it reduces accountability even without succeeding in getting the politics out of monetary policy.

This disconnect with the public ultimately fuels the kind of populist backlash the world has recently seen, further politicising monetary policy with potentially very worrying consequences. This is the paradox of monetary credibility: although economic theory says that monetary credibility and low inflation depend on getting the politics out, at the end of the day – in a democratic society – credibility also depends on the legitimacy of the monetary system and its institutions to deliver policies that work.

Edward Hadas argues that monetary chiefs cling to a dangerously simplistic model of reality and they need a humbler and more realistic approach. As yet, that revolt has not gone far, although Narendra Modi, the populist Indian prime minister, ignored the Reserve Bank of India when he unexpectedly withdrew all high-value banknotes from circulation. But Hadas argues that central bankers elsewhere should not rest easy; their political position is fragile, due to the fact that after failing to forestall a global crisis in 2008 they have presided over almost a decade of mediocre economic growth.

Part of the problem, Hadas argues, is that monetary authorities are fixated on controlling the rate of consumer price inflation (CPI) and they claim to be apolitical and above the financial fray. But these too-simple ideas don’t produce good policies. The monetary authorities should, according to Hadas, abandon their fantasies, beg for multiple goals, including limited asset-price volatility, a healthy financial system, fair foreign exchange rates, strong economic growth and steady job creation, while welcoming closer political supervision.

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  1. Clive

    The main problem I’ve always had with so-called Central Bank independence is that it’s an elevation of privileges bug. Since way back to Magna Carta, societies have wrestled (even intra-elite wrestling, it’s not just a proletariat struggle thing and certainly never started out as such) with what agency, if any, could or should sit atop the apex of power.

    The answer, which has gained pretty widespread acceptance since early medieval times, has been limited to church (an institution which possesses, or should possess, moral authority) and the law (an independent judiciary being the dispenser of legal authority). There’s been a valid intellectual basis for these exceptions to untrammelled state power that — if not without challenges — has stood the tests of time.

    But how on earth did monetary policy creation and policy implementation suddenly get lifted up so that it now sits alongside concepts similar to interpretation of God’s (or a deity or deities) will and justice? That is, though, precisely where’s it’s ended up. Well, if you want to play in the big leagues, like the shakers and movers having, so they claim, a direct line to the Almighty, you’d better be prepared to get some brickbats thrown at you.

    Shorter — if you want the power that comes with bossing people around and having a big influence over their lives, don’t come over all whiny when the plebs complain about how they think u r doin’ it all wrong.

  2. lou strong

    Agree. I requote myself from another debate. The indipendence of central banks is one of those monster-concepts that , as usual , is evoked just to build a smokescreen for us the vile herd , not to say about the fact that the term is sometimes used to give a better name to the term/concept of unaccountability, which could eventually cause some more shadow of suspicion to our weak minds.Being the function of central banks one of the most important of political life, the idea that a central bank could be indipendent should sound quite lunatic to everyone with a minimal level of logic and a minimal respect for the concept of democracy,in other words from a logical point of view either we believe seriously in democracy or we believe in the indipendence of central banks.

  3. ryan

    Very interesting! I would like to add, and this concerns what brought me to NC in the first place, was that a lot of economic concerns in our modern era seem (to me) to have some similarities to the original farmer’s revolt in the late 1800s. It was Lawrence Goodwyns The Populist Moment, that laid out the basic financial sector vs agrarian yeoman sector battle that centered around the issue of the gold standard-and notions of intrinsic value of money being sold to the public by some following the issuing of fiat currency during the civil war. Deflationary pressures and such.. With the populist economic thinkers desiring a less constrained monetary system.

    Of course the historical realities between the two situations have their own peculiarities. But it is fascinating. However I am not so sure of my analysis, is anyone better versed in economic thought care to comment?

  4. James McFadden

    In promoting the idea that monetary policy should somehow be “independent” as a benefit, the questions we must ask are: “independent of what or whom?” and “therefore representing whose interests?” It seems to me that the word “independent” is a red herring used as PR to cover the special interests of the banks and the 1%.

    Which brings to mind two quotes:

    “They ought to be so constituted as to protect the minority of the opulent against the majority.” James Madison

    “The people who own the country ought to govern it.” John Jay

    Central banks are constituted to be anti-democratic in order to protect the interests of the investor class — as have all our institutions since our country’s founding.

  5. Chauncey Gardiner

    “Foaming the runway” for the banks to earn their way out of the financial crisis, as Fed Chair Bernanke and Treasury Secretaries Paulson and Geithner all advocated, merely deferred recognition of necessary economic, legal and regulatory adjustments. QE-ZIRP by central banks globally and financial accounting policies have enabled central bankers, governments, zombie companies and the TBTFs to perpetuate the illusion of recovery, defer loss recognition, and quietly transfer the banks’ losses to others politically while enriching a few. The underlying reality is far different.

    Here in the US corporate stock buybacks funded with ZIRP debt, rising financial securities and real estate prices that slipped into a Ponzi psychological framework some time ago, declining productivity, stagnant real wages and devaluation of labor, marginally profitable shale oil development, environmental degradation, increasing antitrust issues, and secular stagnation are all interrelated. “Populism”?…

    What to do about the elephant in the room through policy measures like government fiscal stimulus and restoration of the Glass-Steagall Act should be on the legislators’ policy agenda, but are not. Seems the War racket and related diversions still hold sway in the Capitol District. Meaningful policy action might require that a currency valuation shift occur first.

  6. The Rev Kev

    I’m thinking that with Central Bank independence that we are getting it all wrong. It should not be the independence of the Central Bank from the State that we should be worried about but State independence from the Central Bank. What put this thought in my mind was what happened with Libya in 2011.
    It had just been destroyed by the west and Gaddafi had been murdered. Jihadists were running around and the situation was chaotic with the signs of a civil war starting to coalesce. So, what was the first priority of the west? It was to form a Central Bank! It was more or less General Order Number One. Not security, not emergency supplies, not refugee control but the formation of a Central Bank.
    Now why would that be?

    1. Chauncey Gardiner

      Interesting hypothesis. If so, what’s the true source of their leverage, who ultimately oversees and manages that leverage, and how do they do so? Based on your insightful observation regarding the priority attached to re-establishment of a central bank in the aftermath of regime change amidst the ongoing turmoil in Libya, I’m reminded of physicist Niel Bohr’s statement, “We are all agreed that your theory is crazy. The question which divides us is whether it is crazy enough to have a chance of being correct?”

      Of course, it could just be that re-establishment of Libya’s central bank was prioritized due to a perception that a sovereign currency is essential to re-establishing a sovereign political framework and civil order, and a central bank is the best vehicle to accomplish this.

  7. Synoia

    The Central Bank should be a department in the Treasury. This “independence” is just a fig leaf to conceal accountability.

    Elections need to be publicly funded.

    Estate taxes conversation. Let the next generation earn their bloody money.

  8. ebbflows

    I’m still of the mind that the dominate economics, which has come to administrate these institutions, has far more agency wrt their operation than anything else.

    Neoliberalism was always a top down affair.

    Nothing less than a reformation in economics can resolve the problem e.g. every time some one or political group win the day they ultimately get read the right act by mainstream economics.

  9. Amateur Socialist

    I can’t help noticing that central banks interest in controlling inflation appears to be largely restricted to limiting wage inflation. Housing, education, medical inflation not so much.

  10. Sound of the Suburbs

    The FED’s track record.

    Alan “Kamikaze” Greenspan


    He’s forgotten the delays in the system.

    There were delays while the teaser rate mortgages reset; the new mortgage repayments became unpayable; the defaults and other losses accumulated within the system until everything came crashing down in 2008.

    Ben Bernanke

    Ben Bernanke thinks “debt doesn’t matter”

    Ben Bernanke is famous for his study of the Great Depression and here it is discussed in the Wall Street Journal.


    “Theoretically, neither deflation nor inflation ought to affect long-run growth or employment. After a while, people and businesses get used to changing prices. If prices fall, eventually so will wages, and the impact on profits, employment and purchasing power will be neutral. Borrowers suffer during deflation because their debts are fixed in value, but creditors benefit because the dollars they get back will buy more. For the economy as a whole, deflation ought to be a wash.”

    What has Ben Bernanke got wrong?
    The creditors are the banks and the repayments go into the banks reducing the overall debt and money supply.
    It doesn’t go to creditors who then get the money to spend.

    Debt does matter Ben.


    He can’t see the problem in 2007 because he doesn’t know where to look.

    Janet Yellen

    Richard Koo had got the answer to Janet Yellen’s inflation mystery.

    They are smarter in the East.

    The West’s “new normal” of “secular stagnation” is Japan’s “old normal” of “secular stagnation”

    Richard Koo knew what would happen in 2008.


    It wasn’t hard.

    The West went through its Minsky Moment in 2008 as Japan had done at the end of the 1980s.

    Richard Koo has had twenty years to study it ……


    It’s called a balance sheet recession Janet.

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