Business Maverick


Central banks’ musical chairs put independence up for grabs

Reserve Bank Governor Lesetja Kganyago during the monetary policy committee media briefing on Janaury 17, 2019 in Pretoria, South Africa. (Photo by Gallo Images / Business Day / Freddy Mavunda)

A changing of the guards at central banks around the world at a time when the value of both political and operational central bank independence is up for debate could yield some surprises. History shows these can be pretty dramatic as tensions run high between presidents and bank governors.

This year there’s going to be an unheralded changing of the guard in central banks around the world, including possibly two new incumbents at the SA Reserve Bank, 11 at the European Central Bank and two new Governors on the US Federal Reserve Board. This high stakes game of musical chairs is taking place at a time when the pros and cons of central bank independence are under the spotlight, up for heated debate and, in some corners, under attack.

Since the promulgation of the Federal Reserve Act in 1907, tensions have run high when it has come to contemplating, or protecting, central bank independence – and now is no different. In 1965, US President Lynton Johnson is said to have got into a physical tussle with Fed Governor at the time, William Martin, after he defied Johnson by raising interest rates. Martin, who was apparently known as the happy puritan, is attributed with a well-known metaphor in economic circles: “It is the Fed’s job to take away the punch bowl just at the party gets going.”

Last week Donald Trump brought his particular brand of exaggeration to the debate, claiming the Dow Jones stock market index would be 10,000 points higher “if the Fed had done its job properly”. However, he, too, is bumping up against those working hard to protect the independence of the Federal Reserve Board of Governors. The president is struggling to see his two preferred candidates successfully voted in. On the weekend, businessman Herman Cain officially withdrew his bid for a seat after four senators opposed his application. Trump’s other candidate, Stephen Moore, is currently making news for all the wrong reasons: his sexist views on women in sport. Moore is an outspoken economic commentator and panned Trump’s appointment of Jerome Powell as Fed Governor.

In Europe, 11 members of the European Central Bank (ECB) Governing Council, six of whom are members of the Executive Board, including President Mario Draghi, will be changing places during a year when elections take place and major politicking is likely. This means the stakes are high for central bank independence, given the ECB is the only effective pan-European policy-making body

In SA, Reserve Bank Governor Lesetja Kganyago’s first term comes to an end later this year but he has availed himself for a second term. Last week Kganyago was given the opportunity to give his perspectives on central bank independence to a global audience at the 19th Annual Stavros Niarchos Foundation Lecture at the Peterson Institute for International Economics. Stanley Fisher, former vice-chairman of the Federal Reserve, introduced Kganyago, sharing a comment by Maria Ramos on his track record at the Bank: “As Governor, he has had to take on an extraordinary defence of the South African Reserve Bank, not only because it is the appropriate thing to do for the Bank but, importantly, it is in the interests of sound and sustainable growth.”

During his speech, Kganyago provided eye-opening insights into the attacks on the Reserve Bank’s independence in recent years. These included “feeling pressure to force banks to service these accounts (for politically connected people), in violation of the law” and “ to allow this family to obtain a banking licence by buying a small bank”. Says Kganyago: “We’ve been on the frontlines lately, the place where good and bad governance meet, and I promise you – in that situation, you really learn to believe in central bank independence.” It is of some comfort, however, that he says he has never received a call from the Union Buildings telling him what to do with monetary policy.

The challenges Kyanyago has confronted during his time at the helm of the bank highlight the much wider ambit to which central bank powers have extended post the crisis, with many central banks now responsible for financial stability and bank supervision, as well as monetary policy.

It also speaks directly to the conundrum at the heart of the global central bank independence debate: whether, within the post-crisis macro-economic environment, it is still necessary to make political and/or operational independence as sacrosanct. To understand what is at stake, it’s useful to consider what qualifies as political independence and what qualifies as operational independence and whether it is necessary to have both.

In putting together measures of central bank independence, economists have broadly included the following as defining political independence: central banks’ ability to set targets, objectives or goals; setting specific rules on senior officials’ terms of office and maintaining general independence from political bodies. Meanwhile, operational independence is generally seen as the ability of the central bank to select and use monetary instruments with autonomy.

The deep debate and research that have gone into these considerations have been triggered by the fact that the monetary policy environment has changed unalterably since the 1970s. In the decades before the 2008 crisis, the key priority was to bring inflation down to a level where it wouldn’t be noticed by the public. Central banks successfully did that, led by the US, where consumer inflation came off its 13.9% high in 1979 and fell to 3.8% just three years later. Thereafter the highest levels of US consumer inflation have been 6.1% in 1990 and 4.1% in 2007.

Post-crisis central banks are dealing with a completely different challenge, to lift inflation up because it is too close to it’s zero lower bound, defined as the point where short-term nominal interest rates are at or near zero, causing a liquidity trap and limiting the capacity of the central bank to stimulate economic growth.

In a Harvard Kennedy School paper, Central Bank Independence Revisited: After the financial crisis, what should a model central bank look like?, authors Ed Balls, James Howat and Anna Stansbury make an important point about the implications for independence in an environment where closer monetary and fiscal coordination undoubtedly will be necessary. They say: “When conventional monetary policy is constrained by the zero lower bound, central banks should take aggressive unconventional monetary policy measures, and coordinate with fiscal authorities on economic stimulus and debt management.”

Their conclusion is that the choice of the inflation target should be within the purview of the government and the central bank should be operationally independent in its efforts to meet that target.

However, they say the costs of political independence may be high if it impedes monetary-fiscal co-ordination and effective macroeconomic stabilisation policy at the zero lower bound.

Interestingly, they don’t come to the same conclusion when it comes to emerging and developing economies. Instead, they say political independence is likely to be important for emerging economies, where institutions are weaker and it is “necessary to restrict any possible pressure on the central bank to pursue too-inflationary monetary policy or monetary financing of government debt”.

So where does South Africa stand on this trajectory? The fact that Kganyago took centre stage at the Peterson Institute for International Economics lecture last week highlights that others want to learn from our experience. Now let’s hope he stays on for another term or, at the very least, is able to pass the baton on to a monetary policy professional who is held in equally high esteem – one who has what it takes to uphold the bank’s institutional strength by successfully navigating the shifting tides of political and operational central bank independence. DM