Tuesday, 24 February 2015

Leave well enough alone

You may have noticed that there is a rather ugly (in my view) effort underway to bring the US Federal Reserve under closer political control. The latest attempt to pass a so-called Federal Transparency Act was introduced by Kentucky Congressman Thomas Massie, who said, "Behind closed doors, the Fed crafts monetary policy that will continue to devalue our currency, slow economic growth, and make life harder for the poor and middle class", a statement which (against stiff opposition) must combine more idiocies in a single sentence than anything else recently spouted by US politicians.

It's easy to smirk at the partisan piffle from Washington, but before we get too sanctimonious it's worth recalling that pretty much every one of our recent general elections has had one political party or another wanting to change our existing - and perfectly satisfactory - monetary policy arrangements. I've covered this before, but in the past few days I've come across a variety of further material which also points in the same direction: when you've got an independent, transparent, and inflation-targetting central bank, don't mess with it.

First, the Money and Banking site had an excellent article, "The Congressional Reserve Board: A Really Bad Idea", which hoed into the proposed bring-the-Fed-to-heel legislation. And along the way it included this graph (which is an improved, easier-to-read version of a graph in the original academic article), and which handily included New Zealand.

It shows how the world used to be: New Zealand used to have the least independent central bank of any developed economy, and consequently had one of the developed world's inflation rates. And countries with the most independent central banks had the lowest inflation rates.

The Money & Banking article also included a link to a poll of expert economists on the issue of potential tighter political supervision of the Fed. The results? As shown below, not a single expert economist was prepared to support the idea: a large majority thought it was a bad idea.

And then I came across this, which I think is the latest state of play as far as academic research goes: a 2014 paper on "The Effects of Central Bank Independence and Inflation Targeting On Macroeconomic Performance: Evidence from Natural Experiments", which is available as a pdf either from the Review of Economic Analysis here or as a working paper here.

Here are the key findings:
The main conclusions are: (1) When a central bank becomes more independent, it lowers the inflation rate and lowers the variability of inflation but has no effect on real GDP or unemployment. (2) When a central bank becomes an inflation targeter, it lowers the inflation rate, lowers the variability of inflation, lowers the variability of real GDP growth and the output gap, and has no adverse effect on the unemployment rate. The real GDP growth rate also increases but the source of this increase is unlikely to be inflation targeting. (3) An inflation targeter that becomes more independent delivers a similar outcome to that of a more independent bank that does not target inflation.
As the article notes, we were at the very front of the pack in adopting an independent, transparent, inflation-targetted monetary policy - "New Zealand made the first move toward greater central bank independence with the sweeping Reserve Bank of New Zealand Act 1989, which created an independent central bank with the single mandate to achieve price stability" - and we were right to do it, and to stay with it. As the article found, and other articles had found before it, there have been big ongoing payoffs, and no ongoing cost. It would be nice to think that come the next general election, the tinkerers-for-the-worse left our monetary policy arrangements alone.


  1. I actually thought you recited your own piffle here. Talk of "independence" is pretty silly, in a country like NZ at any rate. Our reserve bank is tightly legislated, as it ought to be. It will always be right in a democracy that something like a central bank should be regulated by the government, for if not by the voters representatives - then by who?

  2. Thanks for the comment. As the article I cited said, "So, what does central bank independence mean and what are its benefits? Let’s start by clarifying what it is not: independent central banks do not set their own objectives. That authority is reserved for elected officials and governments. In addition, independent central banks are not free of oversight or accountability. Quite the opposite: Elected officials and the public properly expect central banks to explain how they will reach their legally mandated goals and, in the event that they fail, to explain why". Which is what we've got, and I agree with it. But also, "Central bank independence is really about tools. An independent central bank is authorized to use a specific set of policy tools (usually related to its balance sheet and lending authority) to achieve its legally mandated objectives free of intrusive political review in the short term". That sort of independence is worth having, because the evidence is clear that it gives a clear improvement on non-independent ways of doing things