The politicisation of monetary policy

Central bankers have never operated in a political vacuum, even though many of the most important are at least operationally independent. For some, that independence is now being eroded - or even directly challenged. The result is a creeping politicisation of policy, at a critical decision point for monetary policy, which may have long-lasting economic implications.

Ever since Shinzo Abe was elected prime minister in Japan, the Bank of Japan’s policy choices have been subject to overt political pressure, with monetary easing embedded in the government’s economic policy as one of Abe’s ‘three arrows’.

In the eurozone, politicians in member states have rarely felt constrained in offering advice to the ECB, but more recently that background noise has morphed into more intense political pressure, particularly as monetary policy choices have diverged from the preferences in the bloc’s most influential state, Germany.

In the US, President Trump is much more willing to comment on monetary policy than his predecessors. He now says he likes a low interest rate policy - but that did not stop him criticising the Fed for failing to raise rates quickly enough before he was elected. And just this week, he pointedly left open the possibility that Janet Yellen could still be offered a second term, despite his personal criticism of her.

Central bankers will never admit to being politically influenced. For some, politics is beneath them. For all, it would weaken their authority. That is essential, as one of their most powerful policy tools is their ability to shape market expectations and behaviour.

Even though they won’t admit it, all central bankers are acutely aware of the political context they operate in and the standing of their political stock.

While a few might relish provoking political ire, most will be tempted to soften their policy stance, at least at the edges, to avoid provoking personal criticism. That may be human instinct, to avoid unnecessary conflict. Or it might be self-preservation, as ambitious policymakers always have an eye on the next appointment. For every central bank governor of high political standing nearing the end of their career, there is a group of policymakers around them whose next job may depend on their own policy choices and how they justify them.

There are structural and cyclical factors contributing to the politicisation of policy. One is the legacy of austerity and the loss of conventional policy space, which has required governments to look for more indirect ways to control the economy.

Another is the broadening of the remits of central banks since the financial crisis, in many cases to include the supervision of central banks and, in the case of the ECB, a role in overseeing the bailout programmes in some member states. These responsibilities are more politically sensitive and just last month Transparency International criticised the ECB for being drawn into an overtly political role in the Greek bailout. Another factor might simply be that a new generation of politicians is emerging that does not have the same personal investment in protecting the independence of central banks as their predecessors.

The creeping politicisation of monetary policy matters now more than ever because many central banks are entering, or approaching, a critical turning point for policy. There is no ready-made rulebook for unwinding historically unprecedented levels of monetary stimulus. There are difficult choices over sequencing and timing. Nor is there a consensus about what the endpoint for that policy journey should be, given that the neutral policy rate is unlikely to be as high as it was before the crisis.

This means that dispassionate judgements, based on an informed reading of the evidence are essential if the risk of serious policy mistakes is to be reduced. Political interference makes mistakes more likely. That could prove costly.