Tuesday, March 26, 2019

Central Bank Independence

I'm on a panel at the "ECB and its watchers" conference Wednesday, to discuss central bank independence. Here are my comments. Yes, there is a lot more to say, but I get exactly 15 minutes. I hope I'm not scurrying back tomorrow to retract something stupid here.

Central Bank Independence
John H. Cochrane
Hoover Institution, Stanford University
Remarks presented at the “ECB And its Watchers” conference, March 27 2019. 

I believe central bank independence is a good thing, and that it is in increasing danger. I don’t think that’s a controversial view, or we would not be here.

I sense that our mission today is to decry politicians that wish to influence the central banks’ good works, especially by pressing for low interest rates.

But I’ll argue instead that much of the threat to central bank independence stems ultimately from how central banks are behaving, and has little to do with interest rates.


What is, can and should be independent? Let me suggest three principles.

1) In a democracy, independence must come with limited powers, and a limited scope of authority.

2) An independent agency must follow rules, norms, and traditions, not act arbitrarily, with lots of discretion.

3) To be independent, an agency must be, and be perceived to be, competent at its task.

What cannot be independent? A lot of government activity transfers wealth from one person to another, or fights for political power. Those activities must be politically accountable.

Limited powers: Central banks operate within legal restrictions. For example, it seems puzzling that central banks struggle to raise inflation. We all know how to stoke inflation: drop money from helicopters. To stop inflation, soak up the money supply with heavy taxes.

Yet central banks are legally prohibited from this one, most effective action for stoking or stopping inflation.  Why? Well, in a democracy, writing checks to voters or confiscating their hard-earned cash must be reserved for politically accountable institutions.

Rules and norms: Most restraints on central bank actions are rules, norms, and traditions, not legal limitations. Central banking remains something of a black art, so central bankers must sometimes use judgement and discretion, especially in crises, and let the rules or norms evolve with experience. But if they are to stay independent, they must quickly return to or re-form rule, norm, or traditional limitations on their power.

From this perspective, the ECB was set up as an almost perfect central bank. It followed an inflation target. It only acted on the short-term interest rate. Its assets were uncontroversial.  And it was not to finance deficits or bail out sovereigns.

The inflation target and Taylor rule are most important here for their implied list of things that the central bank should not, is not expected to, and pre-ccommits not to pay attention to or control directly: stock prices, housing prices, sectoral and industry health, regional imbalances (especially in Europe), credit for small businesses, income and wealth inequality, infrastructure investment, decarbonization, bad schools, and so on.

An independent central bank should say often, “that’s a terrible problem, but it’s not our job to fix it.” It loses power and prestige in the moment, but gains independence in the long run.


So what are central banks doing to invite challenges to their independence?

Interest rates get a lot of attention, but they are not, I think, the core of the problem. Yes, President Trump is violating established norms by complaining publicly about interest rates. But most people in both parties understand this is a violation, and a norm worth keeping, so for the moment I think the norm against interest-rate jawboning will hold in the future.

The big threat to independence comes from the expansion of activities and responsibilities that central banks have taken on, on an apparently permanent basis, in the years since the financial crisis: Asset purchases, regulatory expansion, a much larger set of goals, and a marriage of regulatory and macroeconomic policy.

Purchasing assets in dysfunctional markets, as in 2008, is what central banks traditionally do in a crisis. (We can argue whether they should, but that’s for another day.) But once markets returned to normal, continuing to buy large portfolios of long-term bonds, mortgage backed securities, corporate bonds, imperiled European sovereign debt, and even stocks, for years on end, was a different choice.

We can argue the benefits. Maybe QE lowered some rates, a bit, for a while, and maybe that stimulated a bit.

But we have ignored the costs. Central banks took on a new, and apparently permanent power, formerly foresworn: to buy assets directly, to control asset prices, not just short term interest rates.

It is harder to say to a politician, who complains that mortgage rates are too high, that this is not our problem; we set the short term rate to stabilize inflation; we don’t pay direct attention to other assets, or to directing credit to mortgages rather than big business.

It will get worse. The US Congress has noticed the Fed’s balance sheet. Under the mantra of “modern monetary theory,” a swath of congresspeople want the Fed to print trillions of dollars to finance the Green New Deal.

The ECB and euro were set up with a clear rule that the ECB does not bail out sovereigns. In the crisis, President Draghi rather brilliantly stemmed the first debt crisis with a “do what it takes” promise, that did not have to be executed, along with a warning that this could not be permanent.

But in response, Italy took the St. Augustinian approach — Lord, give me structural reform, but not quite yet. The ECB continues to repo government debt and Italian banks are still stuffed with Italian government bonds. The doom loop looms still, and markets still expect a bailout.

The ECB has lost the long run game of chicken. It will likely have to actually do what it takes when the next crisis comes.

But there is little that is more political, little that cannot stay independent more clearly, than bailing out insolvent sovereigns, with euros that must either inflate or be backed up by taxes on the rest of Europe.

The ECB is still directly financing questionable banks and questionable corporations. These are also activities that will invite political scrutiny.

The crisis spawned a vast expansion of regulation. The US Fed is now using an immense,confusing, and constantly changing set of rules to act with great discretion on telling banks what to do.

Moreover such regulation changed from “micro,” somewhat rules-based regulation, to more nebulous and discretionary “macro prudential” regulation that directs the activities of “systemic” institutions — something nobody can define other than “we know it when we see it.” The Fed wanted to include large insurance companies, until courts struck that down, and tried for a while to systemically regulate equity asset managers, on the theory that the managers might sell in a behavioral herd and send prices down.

But telling banks and other institutions what to do, who to lend to, when to buy and sell assets, with billions on the line, using a high degree of judgment and discretion, is a political act that invites loss of independence. Your “bubble” is my “boom,” your “fire sale” my “buying opportunity.”

More than current actions, the ideas swirling around central banks seem to me even more dangerous for their future independence.

It is taken for granted that central banks should embrace the task of managing and directing the entire financial system. This only starts with managing bank assets to try to manage “systemic” risks. It goes on to managing asset prices and housing prices, I guess so that nobody ever loses money again, and directing the “credit cycle.” And central banks should go beyond short rates and asset purchases, and use regulatory tools to direct the macroeconomy and asset markets.

Nobody even seems to stop and think that such actions are intensely political, and will invite strong attacks on central bank independence.

Moreover, faith that we economists and the central banks we populate have any actual technical competence to implement such grandiose schemes is evaporating, and rightly so. That the already vast regulatory system failed to stop the last crisis eroded a lot of trust. In many ways the revelation that elites didn’t know what they were doing led to today’s populism. That once this horse was out of the barn, Europe’s regulators nonetheless kept sovereign debt risk free, inviting a second sovereign debt crisis, eroded more trust. If the next crisis blindsides larger, and much more pretentious grand plans, that trust and the independence it grants will vanish.

Even monetary policy is becoming more dangerous to independence. Much of the post-crisis analysis hinges on how monetary policy effects income transfers, for example from investors to mortgage borrowers or from all of us to bank balance sheets. Well, if the point of monetary policy is to take money from Peter, and give it to Paul, on the grounds that Paul has a higher marginal propensity to consume, Peter is going to call his congressman.

I sense that a lot of this expansion of tools, scope, and discretion comes from a natural human and institutional tendency towards aggrandizement.  It’s fun to become the grand macro-financial planner, always in the news. It’s boring to be a limited, technical institution that says “not my job.”

For example, I think a lot of QE was simply done to be seen to be “doing something” in the face of slow supply-side growth. Remember, monetary problems, especially any ill effects of 1% rather than 2% inflation, do not last 10 years. Long run growth comes from productivity, and structural reform, not stimulus, and not money.

But in the language of central bankers, “growth” and “demand” seem to be synonyms. This morning, describing a decline in growth with no decline in consumption, President Draghi used the word “demand” many times, and “supply” never. Like helicopter parents, central banks want always to be in charge.

Maybe you disagree, but think of the costs. For sure, the promise of endless QE, and reiterating the promise that central-bank provided demand stimulus is the vital answer, lessened the pressure for structural reform.

More generally, imagine that about 5 years ago, central banks had said, “We’ve done our job. The crisis is over. ‘Demand’ is no longer the problem. If you think growth is too low, get on with structural reform. Low inflation and interest rates are fine. Welcome to the Friedman rule. QE is over, and we are no longer intervening in asset markets. In place of intrusive bank regulation, countercyclical buffers, stress tests, and asset price management, we are going to insist on lots and lots of capital so there can’t be crises in the first place. We’ll be taking a long vacation.”

Just how much worse would the overall economy be? We can argue. How much better would the threats to central bank independence be? A lot.

Well, it’s not too late.


Let me offer some practical suggestions:

1) Separate monetary policy and regulation. Regulation is much more intrusive, and much harder to resist political pressure. Using regulatory tools for macroeconomic direction is inherently going to threaten independence. The ECB’s Chinese wall between regulation and monetary policy is a good start.

2) Transfer, or swap, all balance sheet assets other than short term treasuries to a “bad bank,” controlled by fiscal authorities.

3) Solve the sovereign debt problem. Stop the doom loop: get own country sovereign debt out of banks, or backed by capital. Create a mutual fund with a diversified portfolio of government debts, and force banks to hold that if they don't want big risk weights. Allow pan-europeans banks that hold diversified portfolios. Then insolvent sovereigns can default without shooting their hostage.

4) Abandon the pretense that risk regulation, asset price management, and credit allocation policy will stop another crisis. Move to narrow deposit taking and equity financed banking, or at least allow these to emerge rather than fighting them tooth and nail.

The US Fed is clearly perceived to be defending monopoly profits of large banks, a big threat to its independence. If you don’t like President Trump’s tweets, wait for President Elizabeth Warren’s. And she knows where the regulatory bodies are buried.

5) Europe needs structural financial reform more than continued bank support from the ECB. For example, corporate bonds should be held in mutual funds marketed directly to investors.

6) Be quiet. Federal Reserve officials should not give speeches about inequality or other hot-button partisan political issues, no matter how passionately they feel about them.

7) But don’t throw away the bad with the good. In the face of political criticism, I sense central banks, rushing to apply the label “normalization.” The Fed is rushing to reduce the quantity of reserves and go back to older reserve management schemes, losing the lessons of how well an abundant reserves system can work.

Independence is not ours to claim. Central banks are government agencies, not private institutions with rights. Governments grant them independence when it is useful for government to pre-commit not to use some of its vast powers for political ends. Independence must be earned by, well, not using power in ways that must be politically accountable.

Central banks need to answer, What economic problems, are not your job to worry about? What tools will you not use? Central banks need to choose the power and allure of trying to fix everything, and thus acting politically, vs. the limitations that allow independence. They can’t have both. And we voters need to tell our politicians which kind of central bank we want. We can’t have both either.

Having laid out the options, it seems clear to me that nobody wants a limited, and hence independent central bank. The trend to central banks as the large, integrated, monetary-financial-and macroeconomic planners, integrating broad control of financial markets and their participants, is desired by central banks, politicians, and not contested by voters. So they shall be, but not independent.


  1. wait what does the green new deal have to do with "market monetarism"? I thought that was "modern monetary theory"?

    1. If you are thinking of Modern Monetary Theory, I have been urging our hos to explain it and the controversy to us, miserable sinners that we are.

  2. What do you think of the Moore nomination?

    1. I don't think we are allowed to use that kind of language on this site.

    2. "Let’s stop to think about Moore’s claim that the Fed should “immediately cut 50 basis points.” In the past when the Fed cut more than 25 basis points it was due to a market crisis. Last I looked the S&P was up 12.5% year-to-date, credit spreads were behaving well and on the whole, financial conditions were relatively easy. From an economic perspective, employment is chugging along nicely and although growth could be better, the United States is still putting up decent numbers.

      It’s into this environment that the Fed should immediately cut 50 basis points? Sure, Stephen - have another drink."

  3. Well, obviously a highly intelligent review of the topic of central-bank independence.

    Yet any independent public agency is probably a recipe for ossification, obscurantism, and self-reverence. With lack of accountability, the problem of industry-capture is amplified.

    I do wonder if the simple prescription of money-financed fiscal programs, operated out of the White House, is a better idea than leaving macro economic stimulus to the Fed.

    In my view, Donald Trump, the Vulgarian talkshow host become President of United States, has been right on monetary policy for the last year while the Fed with its 1500 PhD economists has been wrong.

    I should want an independent Fed?

    1. Seriously....does Trump actually know anything much about economics? If he has been right and the Fed wrong, I suggest that is a fluke. In more general terms, politicians do have a reputation for arranging artificial booms prior to elections when they get access to the printing press.

  4. Regarding MMT and the Green New Deal.

    Actually, in terms of policymaking, the MMT crowd has been running DC since 1980. "Deficits Don't Matter!"

    The debate should be, "Do we remove (effective) MMT'ers from power?" I guess that would mean abolishing the D and R Party

    Remember, MMT is agnostic regarding social vs. military spending.

    One could posit the MMT'ers have financed (by borrowing or printing money) $7 trillion in outlays for MidEast military expeditions since 2000.

    I happen to prefer money-financed fiscal programs to borrowing money, as long as inflation is kept in check, say below 4%.

    I am beginning to wonder why we have a central bank.

  5. Sometimes, after the post-GFC journey, we need to be reminded of some simple truths. This does the job.

  6. I wonder whether, if independence is used for what it it not designed to (financing states), there is not an argument to limit it, for instance, subject the increase of the ECB balance sheet beyond a certain parameter to the consent of the European Parliament.
    Interestingly enough, it does not seem that this is among the proposals brought forward in the upcoming elections.

  7. Should not the independence that has been granted so as to make sure that the parliaments right to approve the budget can be exercised in a meaningful manner also be limited by parliament so that, for instance, the ECB requires European Parliament approval to expand its balance sheet beyond a certain threshold?

    Interestingly enough, such demands seem to not be among those that are being voiced for the upcoming European election.

  8. Interesting and appropriate comments. Ex BoE official Paul Tucker has a longer analysis in his 2018 book Unelected Power https://press.princeton.edu/titles/11240.html . He appears to come similar conclusions. Ian Bright

  9. There is no contract law that makes the Fed independent. Congress always has the right of cancellation, and given the constitution, that right cannot be demoted.

  10. Seriously, could someone please appoint John to the Fed? So much good economic sense combined with good common sense.

    1. Ken, When Trump was replacing Janet Yellen, I suggested this to John, He was gracious at my sincere proposal. His is a voice in the wilderness.

  11. "Central banking remains something of a black art, so central bankers must sometimes use judgement and discretion, especially in crises, and let the rules or norms evolve with experience."

    Oh, it's a black art alright. Recognition and effectiveness lags, coupled with a dual mandate, makes the Fed's job REAL interesting. The Full Employment mandate ends up being political because it affects people's lives and the macroeconomy as a whole -- it ends up creating a feedback loop. The Fed probably juggles more chainsaws given what's on the line that affects the economy, and by natural extension, society.

    I think the Fed does the best it can given the circumstances. They may trip here and there (was 12/2018 a policy error???) but they don't have their hands on all the instruments; fiscal policy is a whole different ball of wax. And so I see this continual wrestling between monetary and fiscal policy. The Fed tries to maintain order while the fiscal side does...whatever it does.

    If the Fed is truly the adult in the room, then its independence is even more critical. Blaming stuff on the Fed may be warranted at times but the fiscal side of things provides never ending opportunities for the Fed to adjust and get set up as the parent who won't let the teenage daughter stay out until 2AM.


  12. independence? You mean the ability to print money and direct it to private banks to be used for their personal gain? Sure it was convoluted...but that is what they were doing! Wall Street takes this money and uses it for PERSONAL GAIN. $4 Trillion was printed by the FED...every dime when to enriching bankers. With a little kick back money Fed officials after the deed is done when the "directors" retire? Tell me why we saved bankrupt banks...to then hand out billions in bonuses for failure? The central banks now are just crony capitalism.

  13. President Elizabeth Warren...would be worse than President Obama for enriching the richest. Democrats talk about fairness...but through actions are shown to be astounding greedy and OWNED by the richest!

    I have lost all faith in Wall Street and the FED for honesty or integrity. The FED is there to enrich the banks...and cover up the astounding debt....$10 trillion under Obama. They are as bad if not worse than Bank of Japan! The FED and many of the central banks of the world have destroyed the future for kids...so Lloyd Blankfien and Jamie Dimon could retire Billionaires(goldman should have failed)...with 100% guaranteed profits by the FED and Treasury! Go read about how capitalism should ACTUALLY WORK!

    1. Have to understand the Fed had to unfreeze credit markets while preventing hyperinflation -- and sterilization worked. A fair amount of bad actors contributed to the mess in 2008 and the Fed did the best they could. Yes, their balance sheet exploded. But the banks serve as an intermediary between borrowers and savers -- yes, they take their slice in the spread, but they lube the economy with access to credit.

      I'm sure we'll encounter another mess in the future that has everyone pointing finger, looking for blame. Ha.

  14. Of course under Obama we had the Fed cutting of interest rates to almost zero to stimulate the economy (a total failure) and then when President Trump came in they raised interest rates. Looking very political! An even clearer example of pure politics is when we had "stagflation" under Ford and Carter, with the Fed failing to do anything. Then the same Fed ended inflation (it in effect stopped the printing presses) because President Reagan had the cajones do it. The Fed makes political decisions, it should be controlled by elected officials.

  15. Prof Cochrane seems to be stumped by a problem which was actually solved some time ago. That’s where he says “We all know how to stoke inflation: drop money from helicopters. To stop inflation, soak up the money supply with heavy taxes. Yet central banks are legally prohibited from this one, most effective action for stoking or stopping inflation. Why? Well, in a democracy, writing checks to voters or confiscating their hard-earned cash must be reserved for politically accountable institutions.”

    In fact the strictly political decisions there can easily be left with politicians, while central banks take the strictly economic ones, like how much helicopter money to dish out. The way to do it (assuming to keep things simple that stimulus is implemented JUST via helicopters) is to have the central bank decide the SIZE OF the deficit, while deciding what % of GDP goes to public spending and how that is split between education, law enforcement etc is left with politicians. E.g. the Fed might say “The deficit needs to be 3% of GDP this year. Here’s the cash.” Politicians can then pitch public spending at 30% of GDP and taxes at 27%, or 23% and 20% respectively, etc.

    Positive Money has been advocating that system for years, but it was recently endorsed by Bernanke. MMTers have yet to catch up with that one. For Bernanke, see his para starting “A possible arrangement…” here:


  16. The Fed did the right thing when it stepped in and provided liquidity to the commercial paper market. Whatever the proper scope of Central bank powers, that seems to be one they should have (I am sure that Bagehot would agree with me).

    QE3 seems to me to have been a step too far: the Fed tried to directly stimulate housing demand (and through that the economy generally) at a time when the Republican Party was trying to introduce austerity. I disagreed with the Republican Party on economic grounds but I disagree with the Fed on political grounds. One of the consequences of the Fed over stepping is that it absolves politicians from the need to act and from the consequences for their acts.

    In all of this we need to remember that interest rates are set in a global market for capital and low interest rates are not a creation of the Fed but rather a result of saving and investment decisions made all over the developed world and some emerging economies. The Fed can influence rates a bit but not very much.

  17. This one pretty much summarizes the content of the blog post


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