The Central Bank Taboo

Donald Trump’s unprecedented attack on the chair of the Federal Reserve, Jerome Powell, has been met with an equally unprecedented defence composed of Ex-Fed chairs, central bank governors, and titans of global finance. Central to this alliance’s criticism of Trump is an ominous warning of disaster to come should the Fed’s independence be violated. For example, European Central Bank President Christine Lagarde emphasised the role central bank independence played as a “cornerstone of price, financial and economic stability”, in a joint statement with leaders of central banks in other developed economies. Similarly, a statement signed by 13 former senior Fed officials warned of “highly negative consequences for inflation and the functioning of the economy more broadly” should the Trump administration threaten the Fed’s independence. 

The seemingly apocalyptic consequences of eroding central bank independence have been made clear, but the concept itself remains conspicuously ambiguous. What exactly should central banks be independent of, and why would the absence of said ‘independence’ cause the harm we are told it will?

Often, central bank independence is presented as a method of insulating economic policy from the arbitrary whim of politics. Indeed, then-Chancellor of the Exchequer Gordon Brown cited the need to make interest rate policy “free of political manipulation” as one of the underlying motivations for making the Bank of England independent under New Labour in 1997. This was understood by Brown as a way of creating a “stable climate for long-term economic growth.” This justification for upholding central bank independence is puzzling, however, given the intimate connection between political considerations and central banks’ purported objectivity.

As the international political economy scholar Jacqueline Best notes, the decisions of central bankers are profoundly political, first and foremost, for their ability to produce winners and losers. The decision to raise interest rates at times of inflation, for example, makes winners of creditors and savers while borrowers are faced with higher day-to-day costs at a time when their purchasing power is weakened. Even the tools used to measure inflation are open to political scrutiny. As the Consumer Prices Index omits housing costs, for example, the choice to base economic policy on CPI figures is implicitly a choice to omit the economic needs of a large proportion of the population from economic policymaking. Indeed, ex-Fed chairman Alan Greenspan admitted in a 2004 speech that most rule-based forms of monetary policy, such as inflation targeting, ultimately rested on discretionary judgments.

If it is not politics that central banks must be independent of, then what is it, and why the apparent confusion? In order to answer this question, it is important to understand the political-economic theory underpinning our current economic orthodoxy and its implications for not only national, but global economic governance.

Central to this economic orthodoxy is a belief (p. 391) that the free market is the most efficient way of allocating a society’s resources and achieving prosperity for its citizens. In addition, mainstream economics today holds that although the market may not function perfectly all of the time, it can be made perfect through a variety of technical adjustments. This is the core insight of neoclassical, or neoliberal, economics promoted by figures such as Milton Friedman and Friedrich Hayek in the 1950s and 60s, which slowly became economic orthodoxy in the 70s and 80s with the collapse of Bretton Woods and the political victories of Margaret Thatcher and Ronald Reagan.

An important aspect of this emerging neoliberalism, and arguably the central cause of its distaste for government intervention, was Public Choice Theory. Public Choice theorists sought to apply their understanding of human rationality, a rationality that sought individual utility maximisation above all else, to the inner workings of political life. In doing so, Public Choice Theory emerged with worrying conclusions surrounding the government’s potential to destabilise the economy when subject to the pressures of mass democracy. The theory (p. 338) goes that politicians have an incentive to lower interest rates and engineer inflationary economic booms, or overpromise in their public spending programmes in the hopes of getting elected, creating instability in the national economy which disincentivises private-sector investment and harms the economy in the long run.

This wouldn’t be a problem, of course, if individuals in a society behaved like the perfectly rational, utility-maximisers economic orthodoxy assumes them to be. Unfortunately, this is rarely the case. In fact, citizens living in a free-market society have a pesky tendency to restrain market freedoms for the sake of greater stability and substantive equality in the form of unions, strikes, or direct legislation. Instead of investigating this near-inherent opposition to the free market and seeing the value in restraining market freedoms, however, neoliberals assume such tendencies are a threat to the system whose fundamental perfection is supposedly unquestionable. Thus, the natural neoliberal response to mass democratic opposition to the free market is simply to take the tools of economic policymaking out of the hands of democratically accountable institutions.

Equipped with this theoretical context, it is easier to understand why the concept of central bank independence is so important for the reproduction of neoliberal capitalism and why there appears to be this confusion about the inherently political nature of central banks. 

In response to the first question, central bank independence ensures that elected politicians, influenced by the popular disapproval of neoliberalism and its social implications, are unable to threaten the market order. Admittedly, I would also be worried for the future of the economy if an individual like Donald Trump got his hands on arguably the most important economic institution in the world. However, we have to ask why Donald Trump was elected as the President of the United States in the first place. As Jacqueline Best once again notes (p. 336), the growth of support for populist leaders like Trump is a manifestation of the anti-capitalist sentiment that in a more freely democratic society would have been channelled into trade union participation or strike action. If central banks and governments did not support policies that work to widen inequality, the ascendance of a figure like Trump to the most powerful office in the world may not have been possible. Ironically, it is the neoliberals who are unable to think long-term in this regard.

Secondly, regarding the confusing messaging surrounding central bank independence, I believe this comes down to the taboo at the centre of liberal democracy. As I have written before, the proponents of capitalism frame the free market as the sole economic system that preserves political as well as economic freedoms. Milton Friedman is famously quoted stating:

“I know no example in time or place of a society that has been marked by a large measure of political freedom and that has not used something comparable to a free market to organize the bulk of economic activity,”

To publicly admit the core tension between the free market and democracy, therefore, would be unthinkable for Western governments which pride themselves on their liberal democratic values. Thus, they are forced to skirt around the issue and speak euphemistically about “political manipulation” and “corrupt bureaucrats” without questioning why the bulk of political opinion points to a distaste of the free market order.

Unfortunately, I doubt Trump’s attacks on Jerome Powell will open up a wider conversation about the democratic legitimacy of central bank independence and its alternatives. Much like Liz Truss’s mini-budget fiasco in 2022, this episode will likely be used as rhetorical weapon to silence any attempts to critically question the economic status quo, that is if Trump’s actions cause the damage we are warned they will. Either way, the issue of central bank independence, and neoliberal authoritarianism more broadly, will continue to be an underlying taboo in our political discourse. The sooner it stops being ignored, the better.

Image: Flickr/The White House (Daniel Torok)

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