With fiscal councils
(or Independent Fiscal Institutions) now commonplace in advanced
economies, a natural question arises. Why are all these councils
advisory, while independent central banks have control over monetary
policy? For fiscal policy we seem to have delegated advice [1], while for
monetary policy we have delegated control. In this post I want to
focus on control over how policy instruments are changed, and not
control of the goals of policy. For clarity assume that
governments still control the ultimate goals of monetary policy (e.g.
an inflation target) and fiscal policy (e.g. a target for the deficit
in 5 years time).
As fiscal councils
are the less familiar, it is natural to try and answer this question
by asking why fiscal councils are not given control over fiscal
policy. I am, of course, not talking about controlling the detail of
government spending or taxes, but instead setting a target for the
projected deficit which governments should aim to achieve in a
budget. There are lots of potential answers to that question, which I
have written about elsewhere.
However we could ask
the question the other way around, and I cannot remember anyone
asking it this way. Why are there no independent advisory central
banks? In the UK, for example, imagine having the MPC meeting, and
then immediately advising (in secret for a short time) the Chancellor
of their recommendation for interest rates. The Chancellor would very
quickly (within an hour or day?) decide whether to accept that
recommendation or do something different. After that, the decision
and the MPC’s recommendation would be announced.
Two straightforward
points. First, a system of that kind could only work in the US if
Congress gave the President the power to accept the Fed’s
recommendation or impose the President’s own decision: perhaps not
something we would want to contemplate right now. In the Eurozone the
ECB would have to give recommendations to Ecofin, which might make it
both impractical and perhaps undesirable. Second, this form of
delegation is obviously weaker than giving complete control to the
central bank, and that in itself may be a reason why it is not
adopted.
Nevertheless, for a
country like the UK, it would be a mistake to underestimate the
political pressure the Chancellor would be under to accept the
central bank’s public advice. The Chancellor or Treasury minister
would be entirely responsible from deviating from the recommendation
given to them, and if it went wrong they would incur a considerable
political cost. In these circumstances, it would be understandable
for governments to reason that there was little to be gained from
having the power to overrule central bank advice. They would get it
in the neck if they overruled this advice and turned out to be wrong,
but equally if the MPC make mistakes they would also have ultimate
responsibility for accepting this advice. If in practice nearly all
of the time they are going to accept the central bank’s
recommendations, why not give them complete control so that at least
you are not implicated when things go wrong.
If this reasoning is
correct, it raises a difficult question for those who argue against
central bank independence but still accept monetary policy’s
primary role in stabilising the economy outwith the ZLB. Of course
many governments used to be happy to control monetary policy, as long
as the advice they were getting was secret. But if that advice is
public, as surely we all agree it should be, would even formally
advisory central banks start to in effect control monetary policy
because governments would never incur the risk of going against their
advice? In which case, why so much fuss about independent central
banks that do control monetary policy being undemocratic? I stress
again that I’m talking about control of month to month interest
rate changes, and not the goals of monetary policy (inflation targets
or NGDP targets). I think those should be democratically decided (as
in the UK, but not the US or EZ), and that central banks should be
accountable in a meaningful way if they do not achieve these goals. But for the day to day business of setting rates, I cannot see that much would be gained by putting those under democratic control.
[1] In the absence of delegating advice to an independent institution, advice would come from the the internal civil service.
