There are no financial philosopher-kings and there can never be any, in central banks or anywhere else.
Napoleon was clear about why he set up the Bank of France in 1800: He wanted a bank to lend his government money when he needed it. As monetary economist George Selgin wrote, “The idea of credit which existed in the mind of General Bonaparte boiled down to this: that he might have all the credit he wanted, if only he could establish a bank he could control, and award it a monopoly of currency.” This nicely sums up one essential function of central banks: financing the government of which they are a part. If you want your government debt to be thought of as nearly risk-free, the central bank has to be willing to buy it at all times.
Somehow, the central banks don’t discuss this service of theirs in their brochures or their public statements. Nonetheless, it is a critical element of whether central banks are, or ought to be, “independent” as they wield their great financial and economic power. If independent, how they are to be accountable, and to whom? Upon the answers to these questions depends the legitimacy (or lack thereof) of these unelected wielders of power in a democracy.
A detailed consideration of what should be meant by central bank independence, accountability, and legitimacy may turn out to be quite complex, as Paul Tucker’s Unelected Power—The Quest for Legitimacy in Central Banking and the Regulatory State certainly is.
Sir Paul, knighted for his contributions to central banking and now a fellow at Harvard University, writes: “Unelected power is one of the defining features of modern governance,” and “central banks are, today, the epitome of unelected power.” He is unambiguous that “What we are dealing with here is power—who has it, for what purposes, and on what terms.”
In turn, this involves “the interconnectedness of events, beliefs, values, norms, laws, and institutions,” with not only domestic issues of economic growth and employment, attempts at financial stability, perpetual inflation (as is these days the central banks’ goal), financial regulation, government finance, and dealing with financial crises, but also necessarily involving international cooperation by central bankers, who thus may be perceived as part of a “transnational elite.”
Over the last century, central banks have become a worldwide institution. In the 1920s, the League of Nations prescribed that “in countries where there is no central bank of issue, one should be established.” In the 1990s, “the International Monetary Fund and the World Bank began prescribing independent central banks and . . . inflation targeting.” In the most recent financial crisis, “central bankers were the leading players.” They “emerged from the crisis with more, not fewer, responsibilities and powers.” Reflecting on this dominant financial institution of our times, “the consolidation of power should make us ponder,” says Tucker. Indeed it should.
Central banks must operate in three interacting aspects of government, in Tucker’s terms: “The Fiscal State, the Regulatory State, and the Emergency State.” As Napoleon saw, the central bank is essential to the Fiscal State; it has become an essential regulator and hoped-for controller of risk for the Regulatory State; and it is essential to coping with financial emergencies and panics for the Emergency State. Central banks “are built to be emergency institutions,” Tucker writes, with emphasis—this is certainly the main reason why the Federal Reserve was created. At this high level of abstraction, the unavoidable complexity is already apparent.
Tucker is well-prepared through long practical experience, having risen to Deputy Governor of the Bank of England, and by much theoretical reflection, to ponder these matters. He spends the first 568 pages of the book carefully examining innumerable aspects of how and under what conditions central banks can legitimately have so much power. He does not sufficiently explore, in my opinion, the dilemma that central bankers can never have the knowledge of the future they would need to carry out their grand goals. Otherwise, the treatment is exhaustive.
The Central Banking Golden Mean
The author wants to avoid two extremes in his search for what might be thought of as the central banking golden mean.
The first extreme is having central banks and money completely controlled by the politicians currently in office, who are ready to manipulate and depreciate the currency in the pursuit of short-term political advantage. Then, as history demonstrates, the central bank can become subject to the government’s whims, as Martin Wolf recently described it. To direct the central bank is doubtless a natural desire of the executive.
President Trump and India’s Prime Minister Modi have both been explicit about this. So, notably, were Presidents Harry Truman, Lyndon Johnson and Richard Nixon, and the executive branch completely controlled the Federal Reserve during the Second World War. Tucker would like a central bank independent enough to resist this natural pressure, except of course, during a big war.
The opposite extreme is a central bank that is too independent, operated by a self-styled set of Platonic guardians who do not have to answer to any mere elected politicians (as they see it), and who by “their professional expertise would improve the welfare of the people.” President Woodrow Wilson helped negotiate and signed the original Federal Reserve Act in 1913. Purely independent central banks would represent Wilson’s theory that independent agencies would be “improved on scientific lines, occupying a sphere separate from politics.” Tucker knows that is not possible in a democratic government, nor is it desirable, leading as it would, in a favorite phrase of his, to “unelected overmighty citizens.” In historical context, Wilson’s “classic celebration of administration looked back to the same exemplars of executive government [as Hegel did]: the Prussian and Napoleonic states.”
Tucker sets out to define in detail a middle ground for central banks. This is to be achieved by conscious design, well considered institutional frameworks, ongoing oversight by the legislature, and informed public debate, which will avoid short-term political domination of central bank actions “without surrendering republican democracy in favor of technocracy.”
When we reach page 569 of this careful and thoughtful book, we find a four-page long list of all the principles needed to construct this central banking golden mean. Entitled “The Principles for Delegation to Independent Agencies Insulated from Day-to-Day Politics,” the list includes “Delegation Criteria,” “Design Precepts,” “Multiple-Constraints,” and “An Ethic of Self-Restraint.”
It’s a reasonable, if lengthy, set of requirements, though naturally some of its points are debatable. Tucker sums up his approach to framing monetary regimes as follows:
a clearly articulated regime, simple instruments, principles for the exercise of discretion, transparency that is not deceptive, engagement with multiple audiences, and, most crucially, testimony to legislative committees; all directed at establishing and maintaining a reputation for reliable, legitimate authority.
Does any existing central bank meet all these criteria? Probably not, Tucker admits. This suggests the unfortunately missing chapter of the book: one that applies the principles to existing major central banks to see how they measure up and that identifies what institutional reforms would be indicated.
It would have been most interesting had Tucker added such an analysis of current central bank designs, judged against his principles. These studies could have included the Federal Reserve, the Bank of England, the European Central Bank, the Bank of Japan, or the Swiss National Bank, for example.
In the case of the Federal Reserve, I believe the conclusion of such an exercise would be that the Fed could not legitimately, and should not have claimed to be able to, set a 2 percent inflation target on its own. This should instead have resulted from an extensive consultation with the legislature. In particular, to unilaterally set goal of having 2 percent inflation forever is of highly dubious legitimacy, when the law instructs the Fed to pursue “stable prices.”
Such an analysis would also lead one to question whether the United States meets Tucker’s standard that “the legislature has the capacity, through its committee system, properly to oversee” the central bank. Any fair consideration, I believe, would find that under current circumstances, the U.S. Congress does not. I have previously suggested that a specialized new joint committee, perhaps called the Committee on the Federal Reserve and the Currency, would have a better chance of carrying out what is, under Tucker’s principles, a mandatory legislative duty.
This is the essential question of the accountability of central banks, which is “the riddle at the heart of this book.” Tucker thinks that “sensible central bankers will want to invest in reasoned debate and criticism of their policies.” (Emphasis in original.) The responsibility of the legislature is “for the people’s representatives to fulfill their own role as higher-level trustees, setting clear objectives and constraints.” One might say in such a design that the central bank is the management of the monetary regime and the legislature is, or should be, the board of directors.
The Claim of Expertise
Supporters of pure central bank independence stress the Wilsonian claim of expertise, the technocratic argument. But although they are monetary and economic experts, do central banks have the requisite knowledge of the financial and economic future they would need for consistent success? It is apparent that they do not. Tucker rightly observes that “bad results are from time to time inevitable.” By analogy, you could be a great expert in the stock market but still be unable to say what stock prices will do today, let alone tomorrow.
Central bankers might have “unparalleled status, power and prestige” but, “as they well know, they, like the rest of us, have a more tenuous grasp of what is going on in the economy than anyone ever expected,” Tucker admits. Or in more informal terms (to quote Wolfgang Muenchau), “The proverbial monkey with a dartboard would have outperformed the ECB’s forecasting department in the past decade.” Hence it is no surprise, as Tucker writes, that we have “a world that combines market failure with government failure.” To expect otherwise would be foolish.
The Governor of the Bank of France, Francois Villeroy de Galhau, in a brilliant talk, pointed out how central banks face four fundamental uncertainties. In my paraphrased summary, these are:
- They don’t really know where we are.
- They don’t know where we are going.
- They are affected by what others will do, but don’t know what the others will do.
- They know there are structural changes going on, but don’t know what they are or what effects they will have.
The unelected power of central banks, however well designed for legitimacy, must always be understood as faced with such inescapable uncertainty.
So, as Tucker says, “Our central bankers are not a priesthood” nor are they “philosopher kings, maestros or celebrities . . . Nor, more modestly, is the chair of a central bank its country’s chief economist.” Not being elected, “they must work within clear democratic constraints and oversight.”
In short, we should be neither idealistic nor cynical about central banks and bankers, merely realistic.