The Governor of the Irish Central Bank, Philip Lane, has called for higher taxes on savings and investment (property taxes). Frances Coppola, in a very clearly argued and well informed article, says this “attempt to dictate to the Government is a serious threat to Irish democracy.” Is it?
The conventional view is that there is an implicit quid pro quo between independent central banks (ICBs) and governments. Governments do not interfere with monetary policy and in exchange central banks do not suggest to governments what fiscal policy, or any other non-monetary policy, should be. It is important to note that this implicit quid pro quo has never seemed to extend to central bankers in the Eurozone, who have frequently pontificated on matters outside monetary policy, so in that context Lane’s comments are not out of the ordinary. But that does not make it right or wrong.
I have argued in the past that the situation where interest rates are at their lower bound requires ICBs to tell governments what to do, or at least say they can no longer do an effective job unless the government undertakes fiscal expansion. In that context I rather like the suggestion in a paper by Ed Balls and colleagues  that at the ‘Zero Lower Bound’ (ZLB) central banks should be mandated to write every three months to the government suggesting how much stimulus they think is required for the economy to get of the ZLB.
The situation for central banks in Eurozone countries is similar in the sense that cannot change interest rates (which are set by the ECB). They do, however, as Frances points out, have responsibility for the health of the financial system in their own economies which requires macroeconomic expertise. So it seems reasonable to apply the quid pro quo to financial supervision by an ICB in a Eurozone country in much the same way it is applied to a ICB that is not in a currency union or fixed exchange rate regime.
But is the quid pro quo sensible in the first place? There is a real concern that an independent central bank might be intimidated by government politicians telling them what to do. That is understandable, as part of the whole rationale for ICBs in the first place is that their independence from politicians gives them additional credibility that they are not acting for political reasons.
The argument for a quid pro quo is that independent central banks should not abuse their authority to interfere with political decisions that have nothing to do with monetary or financial (macroprudential) policy. Let me put a counterargument that I sketched out in a different (UK) context here. While it is obvious no central banker should give advice on who should win the next General Election, that is not what we are talking about here. We are talking about issues were the central bank has some expertise.
Given that, it would be strange indeed if the central bank was prohibited from telling the government what its expertise suggested. You could see the outcry if the ICB guessed a recession was on its way, but kept that knowledge to itself and it subsequently turned out it was right. So in this case Lane would undoubtedly tell the government his views. What we are therefore talking about is secrecy. Is it best that this expertise is kept from the public so as not to embarass politicians when they ignore it? That does not sound so clever. More generally, the lesson of the last ten years is not one where governments would have made good macropolicy if only they hadn't been intimidated by central banks, but rather than in Europe central banks gave bad advice.
I wanted to talk about this particular case because it perfectly illustrates this dilemma. Back in the early 2000s, while he was still a lowly academic, Philip Lane was one of the few public voices suggesting that the Irish Republic needed to use fiscal policy to cool down its economic boom. He was ignored, and the result was a financial and economic crash. He therefore not only has expertise but a reputation for being right on the very issue he is giving his advice about. Is it really better for Irish democracy that this advice is kept secret from the public?
 Balls, E, Howat, J and A Stansbury (2016) 'Central Bank Independence Revisited: After the financial crisis, what should a model central bank look like?' M-RCBG Associate Working Paper No. 67