The Erosion Of Central Bank Independence

Evan Schnidman

Over the last couple months a number of news stories and editorials have pondered the decline of central bank independence. These stories have primarily focused on how various central banks, especially the Fed, will adjust their inflation targeting policy as political pressure becomes increasingly tied to monetary policy. The most astute of these commentaries have suggested that central banks might target nominal GDP as a more technical mechanism to target higher inflation. As a growing body of academic research has noted, new monetary policy mechanisms and increased technocracy have a long history of coaxing the Fed into increased transparency as a means of combating political pressure. So, while some commentators have suggested that the Fed might follow the tack of the Bank of Japan and the Bank of England by opening discussing the possibility of targeting nominal GDP, I don't see such a bold step coming from the Fed anytime soon.

This is not to suggest that Fed policymakers are somehow behind the BOJ or BOE, just that their circumstances are different. Incoming BOJ Governor Kuroda has made it very clear that he is attempting to reach 2% inflation within the next two years. This is a remarkably bold goal for a country that has been struggling with deflation for years and it will require bold rhetoric like ECB President Mario Draghi coupled with bold stimulative measures comparable to the QE done in Britain and the U.S. Unfortunately, most astute central bank watchers have already noted that even with such bold action, Kuroda might not have 2 years to produce results before the market begins to sour on his policies. So, Kuroda's hand is forced to work in tandem with Prime Minister Abe's fiscal policy to make headway toward the 2% inflation target within the next 6-12 months.

Incoming Bank of England Governor Mark Carney faces a completely different situation. With Britain's economy contracting (or nearly contracting) for the third time in the last few years, the Bank has found itself more powerful than ever. Specifically, regulatory powers that the BOE voluntarily ceded in 1998 have been restored and strengthened. However, British inflation is running above target, thus limiting the desire for additional quantitative easing. Nevertheless, recent BOE meetings have demonstrated that a solid minority of policymakers (including outgoing Governor Mervyn King) have supported additional asset purchases to stimulate the British economy, regardless of inflationary pressure. It may come down to politics to determine whether new BOE Governor Carney will tolerate higher inflation to pull Britain from the economic doldrums or whether he is more concerned with maintaining Bank credibility via his mandate to maintain price stability.

Since the Fed has an ongoing QE program, the decision Fed policymakers face is slightly different than that of Japanese or British policymakers; it is a question of how long they will continue asset purchases at their current rate. This week Atlanta Fed President Dennis Lockhart gave a speech indicating that QE will continue through the remainder of 2013 and possibly into 2014. He did not specify that asset purchases would continue at their current rate, but as one of the more hawkish Fed policymakers his words suggest a consensus view that QE will persist through year-end. This does not contradict my earlier prediction that QE will begin to "taper off" in September or possibly as late as December (depending on economic conditions), but it does suggest that even as the FOMC becomes more hawkish in 2014, QE may continue as needed.

Where politics comes into play at the Fed is more nuanced, and like the Bank of England it has to do with regulation. Once again Republicans in the Senate are holding up the nomination of Consumer Financial Protection Bureau chief Richard Cordray as leverage to pull the new agency out of the Fed and make it independent. The goal of this independence is not necessarily better policy, but increased Congressional oversight via appropriations. As part of the Fed, the CFPB is not subject to Congressional appropriations and therefore outside the reach on members of Congress looking to weaken it by squelching out funds. This political pressure does not go unnoticed on the monetary policy side of the Fed, especially on the heels of the misguided election-year push to audit the Fed.

Recent events suggests that Congress is seeking to increase its say in Fed policy, so the Fed is unlikely to open the door to increased oversight by changing the parameters upon which they make policy to a nominal GDP target. Ultimately, this means that for all the talk of changing Fed policy, we are unlikely to see a dramatic shift in the near future, even as politicians continue their efforts to chip away at central bank independence. Asset purchases are likely to be the policy of note for the remainder of the year and even with continued murmuring about a shift to nominal GDP targeting or a higher inflation target, I still expect my initial timeline of QE tapering off beginning in September and lasting into 2014 to be roughly accurate. If anything, President Lockhart's speech might push this timeline to QE not beginning to taper off until December, but either way investors should expect asset purchases to continue for several months before slowly drawing down in 2014 under a more hawkish FOMC.

Source: Fed Playbook





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