Central banks: How independent are they?

4 Feb 2023

It is natural to expect that if the original goal of improving de jure central bank independence were to reduce political interference, de jure independence should be negatively correlated with politically motivated appointments. Therefore, if the stated goal is to make the central bank more politically independent, then we should expect less politically motivated governor appointments so that de jure independence more convincingly becomes de facto independence. This intuition suggests that the correlation between metrics of de jure independence and more independent governor appointments should be positive. However, a positive correlation is not the only possible outcome. Political processes have a status quo bias, either because political habits are hard to change or because laws are very hard to reverse. Politicians used to appoint close allies at the central bank might look for alternative ways to circumvent the enacted central bank independence legislation, especially when reversing such legislation is difficult. Therefore, the correlation between de jure independence and more independent governor appointments may disappear, or even turn negative, if politicians actively seek to reverse the legal reforms by appointing central bank governors with close ties to the government … we hand-collect systematic information on 316 central bank governor appointments in 57 countries between 1985 and 2020.

Countries around the world have reformed the legal framework governing their central banks to increase operational independence. This column provides evidence that over the past decades, appointments of central bank governors have become more politically motivated, especially following significant legislative reforms aimed at insulating central banks and their governors from political interference. Politically motivated appointments reflect lower de facto independence and are associated with worse inflation and financial stability outcomes.

Since the late 1980s, many countries have reformed the legal frameworks governing central banks to protect these institutions from undue political influence and safeguard price (and financial) stability (Grilli et al. 1991, Cukierman et al. 1992, Romelli 2022).

However, legal or de jure independence does not necessarily translate into actual or de facto independence. Laws are incomplete, and even when the law is explicit, actual practice may deviate. Policy reforms may also give rise to a ‘seesaw effect’ – when a policy reform takes place in one dimension but the political equilibrium remains largely unchanged, politicians may try to use a different instrument to attain the goal previously targeted with the instrument that is being reformed (Acemoglu et al. 2008). One way in which politicians may seek to retain control over monetary policy is by ‘getting their own people into the top jobs’. Anecdotal evidence consistent with this idea is plentiful. For example, The Economist noted a few years ago that “President Donald Trump has demanded that interest rates should be slashed, speculated about firing the boss of the Federal Reserve […] India’s government has replaced a capable central-bank chief with a pliant insider who has cut rates ahead of an election […] Rather than win by force of argument, they are seeking an edge by getting their own people into the top jobs” (The Economist, 13 April 2019).

In a new paper (Ioannidou et al. 2023), we examine whether central bank governor appointments have become more or less political, following significant legal reforms aiming to insulate the central bank and its governor from political interference. We define a politically motivated governor appointment as one where the appointment is skewed towards a candidate who is more loyal to the executive making the appointment rather than the central bank mandate. Furthermore, we study whether politically motivated appointments relate to central bank policy outcomes. We should clarify upfront that our paper does not inform the debate concerning the appropriate, or even optimal, level of central bank independence. We focus on central bank governors because of their disproportionate importance in running the central bank….


Source: Adam Tooze: Chartbook