A short while ago there a considerable degree of attention was placed on Bernie Sanders’ economics policies, with one aspect of them in particular demonstrating his lack of economic understanding. In particular, Bernie Sanders supports legislation to “Audit the Fed”, which would see the Federal Reserve’s monetary policy decisions come under intense scrutiny from politicians. In other words, this legislation would remove the independence of the Fed to set its monetary instruments in a way that would allow it to achieve its monetary policy goals, and instead render monetary policy a tool to be exploited by politicians once more. In other words, Bernie Sanders supports revoking central bank independence.
The rationale for having central bank independence in the first place is to prevent political meddling in monetary policy. There is a well-established literature regarding how governments’ desires to be re-elected results in them manipulating monetary policy in the run up to an election and how such manipulations are detrimental overall.
Intuitively, in the run-up to an election, a government would want to boost the economy so it can get re-elected, and therefore would set interest rates lower than they should be otherwise, such that voters would associate them with economic growth and hence be more likely to re-elect them. After the election, the government would need to raise interest rates more than they would have done otherwise so as to prevent the economy over-heating. This gives rise to the phenomenon known as political business cycles – in essence, booms and busts are artificially created by the presence of elections.
By handing the control of monetary policy over to an independent central bank, this potential for political business cycles is reduced. The independent central bank’s motivations do not include being re-elected and therefore monetary policy under their control would not be subject to unnecessary changes before/after elections. Instead, interest rates would be set solely to benefit the economy as a whole.
(There are, of course, distinctions to be made in terms of whether a central bank is “goal” or “instrument” independence – the former is where the central bank itself decides what the aims of its monetary policy should be, whereas the latter is where the goals of monetary policy are set by the government but the central bank can choose how best to achieve those goals. Even the latter would reduce political business cycles due to the increased transparency in what monetary policy is trying to achieve preventing politicians being able to change those goals in the run-up to an election.)
In this regard, Simon Wren-Lewis put forward (as a devil’s advocate exercise) what he felt to be the strongest argument against central bank independence. Although Wren-Lewis’ point is needlessly drawn out, what it boils down to is this: that delegating monetary policy to an independent central bank meant that governments came to the view that managing demand was the responsibility of the independent central bank while fiscal policy (remaining under governmental control) should be used for political rather than economic purposes. Although this would not usually be a problem, when interest rates are close to the zero lower bound, then fiscal policy should be used to stimulate demand so as to allow an economy to recover. Wren-Lewis posits that this potential use of fiscal policy has been neglected due to politicians viewing demand stimulation as, essentially, “not their problem” and that this political attitude is due to the creation of independent central banks.
If this is indeed the strongest argument against central bank independence, then it is clear that the case against such independence is extremely weak instead. In particular, the entire argument rests on the assumption that interest rates are the only instrument available to an independent central bank. As has been shown by the use of quantitative easing and numerous discussions regarding “helicopter money”, that assumption clearly does not hold.
Furthermore, Wren-Lewis claims that a government concerned with a fiscal deficit cannot also try to stimulate demand at the same time. This ignores the re-distributive nature of fiscal policy. In particular, fiscal policy tends to take more in taxes from higher-earners (i.e. those who save more as a proportion of their disposable income) and less in taxes from low-earners (i.e. those who spend more as a proportion of their disposable income). Similarly, government benefits tend to be given to those who spend more as proportion of their income rather than those who save more as a proportion of income. Hence, it is entirely possible for fiscal policy to reduce a deficit overall, yet still stimulate demand by increasing overall taxation and/or decreasing overall spending, but increasing the redistribution from high-earners to low-earners. In other words, even if fiscal policy is concerned with reducing the deficit, it can still be used to stimulate demand when interest rates are near the zero lower bound and a government wants to reduce the fiscal deficit.
Hence, as shown, the case against central bank independence is so weak as to be non-existent. So, back to Bernie Sanders and his support for revoking the Fed’s independence – this support for an incontrovertibly nonsensical economic policy shows that he is economically illiterate. That he has come so far in the US Democratic Party’s primaries shows just how little importance voters in those primaries place on the impact that politician’s policies would actually have.