Corbyn and the attack on Central Bank Independence

bank of england

The ascendancy of Jeremy Corbyn in the Labour leadership race and discussions with Richard Murphy in the media have brought to public attention a debate about the purpose of central bank independence. This is something I have written about extensively, so this is a good opportunity to offer some context for the readers of this blog. Corbyn is right to raise this, as an integral part of the way the market-state relationship is balanced today is the idea of institutional independence from political control. How did however institutional independence come to be accepted as best practice in the design of regulatory frameworks?

Historically, attempts to depoliticise banking rested on distrust of the capacity both of politicians and of the public to behave in a way conducive to a nation’s best interests.

Thomas Hutchinson, an 18th century governor of Massachusetts, for instance, declared that ‘the great cause of paper money evil was democratic government. The ignorant majority, when unrestrained by a superior class, always sought to temper with sound money’. The very concept of central banking is, perhaps as a result of beliefs such as Hutchinson’s, associated with secrecy and intrigue. The idea of an American central bank was formulated in a secret meeting in 1910 on Jekyll island, where participants travelled pretending to be taking part in a duck hunt. As a result of processes starting at that meeting, the Federal Reserve was created in 1913 to implement banking and currency reforms with the aim to prevent periodic banking crises, such as the panic of 1907. Central bank authority focused on ensuring that the value of money was not undermined by inflation, an idea consistent with Hayek’s argument that mechanistic rules ought to limit the central bank’s discretion (and as a consequence the influence of political processes over central bank policies).

Focusing on the purported depoliticising effects of independence, we could see New Labour’s decision to give the Bank of England operational independence as a decision responding to a change of belief-system, not an economic one. It established New Labour’s anti-inflationary credentials and delivered on the party’s campaign promise to de-politicise the setting of interest rates. In fact, Bank of England independence forms part of a global trend during the 1990s, when more than 30 countries passed legislation increasing the legal independence of their central banks and represents one of the most dramatic changes in monetary frameworks since the collapse of the Bretton Woods regime. Bank of England reform came a decade after the start of the trend in central bank independence, which began with the 1989 reform of the Reserve Bank of New Zealand. The British decision, however, was not linked to changes in Britain’s exchange rate regime, the collapse of the former Soviet Union, the adoption of an IMF programme, the decision to join the Euro area – explanations that cover most cases of central bank reform in the 1990s, but it was motivated by the internalisation of the idea of independence by the labour leadership. A similar ideas-based explanation can be found for the German Bundesbank’s independent structure. The Bundesbank’s independence resulted from the balance of power politics in Western Germany that could only be maintained by detaching government from the setting of monetary policy.

The core of the intellectual case for central bank independence revolves around the assumption of a persistent inflationary bias built into politicians’ monetary policy preferences.

It is argued that this bias can only be negated by vesting authority in policy makers who can be trusted to choose a policy rule that is non-accommodating of inflationary tendencies; namely central bankers. Central bankers are assumed to be better placed than politicians to enforce such a rule, since there is no clear symmetry of interest between the central bank and the labour market in the way that there is between the government and the labour market. Put in a simpler way, there is an assumption that political control over monetary policy makes the business cycle dependant on the political-election timetable, with politicians trying to manipulate economic performance to gain short term political gain.

Research certainly finds that the conservative governments that preceded Labour prior to 1997 engaged actively in trying to manipulate economic indicators for political purposes. Accepting this argument as to the perverse incentives of politicians and their effects on distorting the economic cycle is a key precondition to allowing the idea of independence as a beneficial change to take root. The de-politicisation of central banking and the transfer of control over interest rates to independent central banks was also a key consequence of the success of the argument that Keynesian demand management was illegitimate. This was largely achieved by Friedman when he sought to demonstrate that a market economy would tend to gravitate towards a natural state of unemployment determined crucially by the cost of productivity and the distribution of labour. For this reason, governments, Friedman argued, could not affect the rate of unemployment in the long term, unless they increased spending and cut taxes, which would result in an expansion of the money supply, and thus inflation. Friedman’s imperative to maintain monetary and fiscal stability could only be sustained therefore if the economy was run on an ‘autopilot’ for regulating the quantity of money. This autopilot was achieved via the ploy of institutionally independent central banks and inadvertently led to a re-naturalisation of economic relations. Such re-naturalisation of economic relations suggests a return to the view that market processes need no state direction that last held sway prior to the Great Depression.

The orthodox account of economic justifications for central bank independence miss-specifies the whole nature of monetary relations within contemporary capitalism.

In examining justifications for central bank independence I remain unconvinced with the three foundations of this idea. The three foundations are the success of the Bundesbank and the German economy, the academic literature on the assumed inflationary bias of politicians, and the literature on the effects of central bank independence. Bundesbank’s unwavering inflation targeting has been very costly on German growth and sparked a number of serious recessions. Also inflation targeting, as a goal of monetary policy does not automatically require the independence for the central bank, and further that the causal relationship between strict monetary policies and independence is not one-directional. It could be for instance, that countries have independent banks because they have chosen monetarist policies and not the other way around as commonly assumed.

This presentation of the reasons for the proliferation of the idea that institutional independence (in general and central bank independence in particular) is beneficial, allows us to return to a consideration of the place of technocracy in modern economic governance.

The politics of macroeconomics is not so much the struggle for the authority to impose efficient institutions, as it is the struggle to legitimize self-appointed authority on the basis of technical expertise.

The most important question to ask about the process of central banking therefore is who defines the social welfare function that acts as the guide for central bank interventions in the economy? Yet, this question cannot be asked within an orthodox intellectual framework that essentially denies the constitutive role of politics in the economy. Within orthodox macroeconomic analyses, the social welfare function is said to approximate the policy preferences of the ‘representative’ individual within society. However, those models conceptualize the representative individual as one who adopts the same cognitive approach to the question of monetary policy-making as that of orthodox macro-economists.

By little more than a definitional trick, it seems, orthodox macro-economists are thus able to elevate themselves to the position of legitimate intellectual guardians of society’s concerns for the key settings of economic management.

Stiglitz offers a summary of his critique of the idea of the ‘rational’ individual in Freefall (2010) and concludes that homo-economicus is just a useful fiction that has been mistaken by economists as a description of reality. This fiction is then used to assess policy and to predict behaviour leading to patently unrealistic results. Such a result is similar to the one discussed above, of mistaking consumer choices with citizen choices, of a democracy of means with a democracy of votes.

The intellectual case for central bank independence is therefore less clear than its current political appeal would seem to suggest.

It is undeniable however that financial markets have a significant impact on the way in which society is organized, since the allocation of credit is the sine qua non of distributional politics. Consequently, when the decision to cede operational autonomy to central bankers is justified in terms of the need for market sensitive policies, it is equally clear that a particular way of organizing society is being simultaneously constructed and defended against possible redefinition. As a result, the social basis of financial trading has changed markedly in recent years in a way which is selective of a social structure of accumulation grounded in the monetary orthodoxy that central bank independence was designed to deliver.

Corbyn could therefore be right in seeking to expose the politics that lie beneath the Bank’s façade of independence.



12 thoughts on “Corbyn and the attack on Central Bank Independence

    • Hi Peter,

      maybe you can explain to this slightly handicapped or slow learner:

      Your comment indicates you have a far better grasp to bridge times, perceptions, technocrats, problems and their respective solutions, outside the horizon of possible unwished-for consequences, from the no doubt still openly authoritarian Thomas Hutchinson to Joseph E. Stiglitz’ revelation that there may not be a “rational consumer” after all?

      But without any doubt “rational voters”, beyond a growing section of non-voters, and carefully aligned technocrats that serve only their respective winners wishes? And they should be able to change established rules based on their own needs only?



      • LeaNder,
        You pay me a complement which I maybe do not really deserve, at least not yet.

        Like you, I have been going through a steep learning curve regarding many of these economic issues. My profession is not in academia, finance or economics. I am an engineer!!

        I always apply the “Peter Smith Anti-Gullible Rule”: read what is written, be critical but open-minded about the content and then make your own mind up. Don’t just take the source as the absolute truth.
        It is a strange phenomena that often less knowledgeable people see the flaws more easily in an otherwise expertly written article.

        Regarding Central Banks: Ioannis is far more knowledgeable than I am on this matter. However, my recent studies have led me to the conclusion that for a country’s economy to be robust and successful, the Central Bank of a country must work “for and under” the government. And there are many reasons why this must & should be so, not least of all because one of the primary functions of a government is to look after its citizens. Central Bank “independence” is often at odds with this goal. The only thing that I can think of that makes central bank independence a good idea is to counter the fear/likelihood/possibility of politicians in power using Central Bank powers in a negligent way, that would then adversely affect the country’s economy. This is usually the main reason given for advocating central bank independence. There are a few other more sinister reasons, like making it more easy for commercial bankers to run the show, to the detriment of the many and to the benefit of the few, but I will leave that up to you to decide on which “conspiracy theory” you wish to believe.

        I have quite a few posts on my blog where experts & commentators discuss these issues in more detail.


  1. Thanks Ioannis, that’s quite a bit of tough material, you’re keeping our minds active 🙂

    I don’t have a reputation to keep high, so let me write a couple of things in easier language.

    (1) Keeping up with the Joneses

    When I have a swimming pool in my backyard, my neighbor will want one too, and if he can’t afford it, he’ll find a bank that is careless enough to lend him the money. Who cares if he can’t pay back, banks have plenty of money, right? [or so the public opinion goes]

    That’s also what politicians do: buy votes with excess promises (above what can be financed with taxpayers’ money), promises that can be paid for either with freshly printed money or with public debt or possibly with Robin-Hood money by sending the bill to others. It works fine as long as you control the printing press or as long as there are other mechanisms that cause enough inflation to erode the debt. Of course inflation also erodes the savings of you and me, but usually that’s no real concern for politicians of the left.

    In summary: mankind will always devise magic tricks to drag “future” money into the “present” and spend it now (until the bubble bursts). That’s human nature. Hence I believe it’s better that independent professional technocrats (central bankers) keep professional demagogues (politicians) in check. In essence, central bankers ought to care for the “fiat” (trust) of fiat money. That’s because (since around 1971) gold can’t do it anymore, there’s by far not enough gold in the world to cover todays monetary needs for the real economy.

    (2) The obsession with growth

    Most macro-economists (and mankind in general) are obsessed with “growth” as if that were a natural thing. Note: the average person may be satisfied with the “illusion” of growth (nominal growth by inflation not corresponding with real growth). I guess that’s why the ECB sets its inflation target at “2 percent or slightly lower”.

    However… on average and in the very long run, growth of per-capita “real wealth” (economic goods and services) corresponds to growth of per-capita productivity. Man can’t consume what hasn’t been produced. Contrary to what some politicians may believe, real wealth can’t be printed with the money press (only illusion of wealth can be printed, not the real thing).

    When making the calculations over 2,000 years (200 BCE to 1800 CE) worldwide one finds real per-capita growth of no more than 0.10 to 0.15 percent per year (as I remember… I’ve done such calculations years ago but didn’t care to keep the details). Nowadays man seems to expect sustained growth rates of several percent per year. Is that realistic? Open question. There have been productivity improvements of this order in the 19th and 20th century due to rapid advances in technology, but there are signs that this period may have ended.

    (3) German obsession against inflation

    The obsession is even stronger than America’s obsession with the Great Depression, and it’s easily understood. When uncontrolled, inflation can explode as happened in Germany in the twenties. This hyperinflation caused massive misery, the collapse of the Weimar republic and Hitler’s rise to power. Never again, please.


  2. “In summary: mankind will always devise magic tricks to drag “future” money into the “present” and spend it now (until the bubble bursts). That’s human nature. ”

    Eric, I am not really sure, if that is “human nature”, beyond maybe ads that use this imagery … at least there was once a TV ad that caught my attention. It played with this imagery: my house, my boat, my car, my wife. Featuring a guy slapping photos on a table trying to impress the male he met.

    I hardly ever pay attention to ads, but this drew my attention. To the extend I recall, it seemed to be a bank ad. … We can help you to get there, so to speak.

    Judging matters from “the left”, not necessarily the “Greek left collectively” but no doubt some of them nevertheless versus whatever is in the larger scenario, maybe “the right”/maybe one should call them the personal advantists. or high profile gamblers. E.g. the professionals developing all these expert financial tools: Growth without any given natural limit. You can sell to your own heart’s delight as long as you have a longer Securitization plan and escape route in mind.

    After business accomplished, you develop the myth that the housing bubble in the US was ultimately created by the “unwashed masses” that did not give you solid details about their real economic longterm abilities. Meaning not only the ones that got into hardship, but the larger masses.

    Meanwhile you sent out high profile actors to sell the bundled triple AAA products anywhere and wash your hands after.


    But yes, I wonder to what extend at one point the average US citizen was lured into buying a house. And to what extend this average user really mattered. Ever.

    I recall that in the early 2000s I got a spam trying to recruit me into huge projected American real estate fund gain. The offer was of course highly suspicious, 27% or something. But yes, occasionally i take a look at spam. Attempt to dilute losses? A not quite so careful one? How many may have responded?


    I often encounter Americans that guided by a look at statistics wonder, why there aren’t more homeowners here in Germany. Or so comparatively many renters only. This means, we may not be a really democratic state, were anyone can afford a house? Maybe since no German bank would grant you a loan without solid credentials? I have no idea. I also wonder why we should be judged on these statistics.

    I live in a city, and I do not own a house by the way. Should I care???

    “Nowadays man seems to expect sustained growth rates of several percent per year. Is that realistic?”

    It’s a peculiar and it feels very, very dangerous idea.

    Yes in this field as someone from the humanities, I may have indeed a very, very conservative core. No doubt the European union had the basic idea of equalizing economic conditions everywhere longterm.

    Once while supporting my niece in writing her thesis, I looked into a EU related publication in the IT field. There was one single paper addressing the possible social results in the larger context. Basically the two authors could have had the larger Russian privatization/loan for shares scenario in mind, it did not surface. But they suggested that any kind of pure market oriented programs would necessarily create a wider rift, with a lot of people getting into serious hardship and the EU had to be prepared for that.

    But pray tell me, is the shift back to the communist model the only way out?


  3. Ok, the thoughts of an illiterate.

    An economy needs money, like a plant needs water. You can, like a plant, drown it of starve it from money. The problem is to get the quantity right.

    The creation of money seems to me the privilege of a countries government. Which, after all, represents the will of the people. Once created, it should be made (free of interest) available to banks who will take care of further distribution. Although the right to create money belongs to the people, they should also be obliged to consult experts on these matter. A central bank.

    For countries with a well developed system of tax collecting there shouldn’t be any need for internal devaluation. After all, devaluation is nothing but an extra taxation.

    Further I would like to see a national system for money transfers. We once had that, based on the postal service. Was called Giro and (as efficiency was concerned) way ahead of what the banks could offer at that time.

    Money within that system should be 100% safe. Money deposited at banks would be available for investment, therefore would earn interest, but also carry a risk. No more need to save them with taxpayers money.

    What does this make me? A Marxist? A libertarian capitalist? I haven’t got a clue, but I do not like the present system whereby commercial bank create money by creating debt.


    • That was definitely NOT the ramblings of an illiterate, Pim.

      What you have written is rock solid logic and common sense. Especially if one has the interests of a nation at heart instead of one’s own pocket!

      I am wondering now whether you are actually a reformed political economist?


    • Pim> What does this make me? A Marxist? A libertarian capitalist? I haven’t got a clue, but I do not like the present system whereby commercial bank create money by creating debt.

      It makes you an advocate of gold standard and full-reserve banking.

      Most monetarians would argue that such a restrictive money supply is largely insufficient to cover the monetary needs of today’s real economies (real i.e. for transactions of real goods and real services).

      It’s understandable that many people are anxious and angry with the thin-air money shuffling frenzy of financial markets. Unfortunately it also casts shadows of suspicion on responsible, prudent bankers.

      It’s actually a matter of maintaining the right balance, by appropriate monetary policy and regulation… the money supply must be wide enough for the real economy, but not very much more.

      On money supply cfr for instance
      (Thousands of books have been written on the subject).


      • @ Erik,

        Gold standard is too small a basis. I can understand that, but I’m trying to come to grips with full. reserve banking. I’m half-way thru a book that is trying to explain that to me.

        My understanding so far is that there should be two types of banks. One that can’t go bankrupt and another that can, but brings in higher reward for the depositor if he choses to bank there.

        Anyway, the silliness of taxpayers rescuing banks should come to an end. The same should apply to the creation of money I guess. You mentioned already the danger of politician creating booms by increasing the money supply in order to secure re-election.

        I am aware of that too. But they can do that already by over borrowing. The present system is obviously very profitable for the banking industry, so they will fight changes tooth and nail, but changes should be made.


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