Central bank independence needs a better defence: Peacock

Zawya

3 days ago

(The opinions expressed here are those of the author, a columnist for Reuters.)
LONDON - Investors may be fixated on Donald Trump's attacks on the Federal Reserve, but the Bank of England also faces increasing political scrutiny, raising alarm bells about the future of central bank independence.
The U.S. president has fired a regular volley of vitriol at Fed Chief Jerome Powell in recent months, demanding interest rates cuts and hinting that he will appoint a presumably more like-minded replacement when Powell's term ends next year.
While Trump is not the first U.S. president to try to pressure the Fed since it formally became independent from the Treasury in 1951, his attacks are the most public, and this has caused some market wobbles.
That's because history suggests that independent monetary policy is better at keeping prices in check than having politicians control interest rates, as the latter may be keen to keep borrowing costs low no matter what.
The U.S. bond market has been unnerved by some of Trump's comments about the Fed in recent months, particularly when he wrote in April that Powell's termination 'cannot come soon enough.' But investors appear to be increasingly inured to the president's rhetoric, believing he will back down before doing anything truly destabilising.
Relying on the markets as a safeguard, therefore, may not be enough.
The Fed would be well advised to gird its defences in advance of Powell's departure, and one opportunity to do so is its periodic strategic review set to be unveiled this fall.
The last review, in 2020, made the Fed's inflation targeting more flexible, allowing for periods of moderately higher inflation to balance times when it dropped below target.
At a time when the U.S. president is both pressuring the Fed to lower interest rates and pursuing trade policies that could be inflationary, the Fed would be wise to drop the 'flexible' approach and instead focus on meeting its inflation target at all times.
That would send a clear message to the American people that its top priority will be tamping down the cost-of-living pressures that have hit hard since 2021, helping to bolster its legitimacy with the public.
FISCAL PRESSURE
On the other side of the pond, the Bank of England is also facing questions about the way it operates.
Britain's insurgent Reform Party, which holds a consistent lead in opinion polls, says the Bank wastes billions of pounds of taxpayers' money by paying interest to commercial banks on their reserves and should therefore stop doing this. It has also suggested one or more government officials should sit on the BoE's Monetary Policy Committee.
Bank Governor Andrew Bailey pushed back in a published letter, arguing that if the official interest rate was not paid on reserves, the transmission of monetary policy to the real economy would be hampered and banks would be tempted to reduce those holdings, potentially creating a financial stability risk. He also offered a cogent defence of the ongoing benefits of quantitative easing as well as the costs.
Importantly, if this government or a future one were to mandate a change to the BoE's reserves regime, it would smack of 'fiscal dominance', whereby high government debts influence the way a central bank operates. Once that box has been opened, it could lead to speculation that interest rate changes were being swayed by the same factor, a massive red flag for investors.
ROOT-AND-BRANCH REVIEW
The UK government's last root-and-branch review of the Bank's remit was a decade ago. Given everything that has happened since then – Brexit, COVID-19, the cost-of-living crisis – it is time for another look and would give the Bank a forum to clarify its goals and available toolkit.
To silence doubters, many issues need addressing, including the diversity of thought on the Bank's policy committees, accountability to parliament and the public, the breadth of its remit, the interplay of monetary policy and financial stability and the Bank's communications.
Moreover, given that quantitative easing was a leap into uncharted waters, there are legitimate questions to ask about its effectiveness, its wider impact on the economy and its reversal via quantitative tightening. The Bank is closing in on its Preferred Minimum Range of Reserves, so it is a good time to evaluate this program and then communicate the findings clearly to the public.
And now is likely a good time to act. It was only three years ago that then-Prime Minister Liz Truss attacked the Bank for not foreseeing the market's reaction to her ill-fated budget. Attempting to make any changes to BoE policy in such a charged environment would have been very challenging.
In stark contrast, current Finance Minister Rachel Reeves, a former BoE employee, has pledged not to interfere with its independence and would thus be far less apt to politicize any Bank action. The same won't necessarily be the case with whomever succeeds her.
As former Bank of England Deputy Governor Paul Tucker said at a recent conference in London, the best way for central banks to preserve independence is to 'do their job, stick to the mandate, explain it as clearly as possible. Don't try to intervene in politics'.
The problem is that politics may continue to interfere with them.
(The views expressed here are those of Mike Peacock, the former head of communications at the Bank of England and a former senior editor at Reuters).
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(Writing by Mike Peacock; Editing by Anna Szymanski and Lincoln Feast.)