Voice

Has independent central banking jumped the shark?

As European leaders meet -- again -- to figure out what to do about the Eurocrisis, Business Insider's Pascal-Emmanuel Gobry fires a broadside at the entire edifice of independent central banks: 

If one myth has been slain by the financial crisis and the response to it, it's the idea that central banks ought to be independent and unaccountable politically.

The idea of central bank independence was that it would guarantee good monetary policy. During the Great Moderation it certainly seemed that way. But now it's no longer the case...

[The] point is that the choice between inflation and unemployment is a political, not a technical choice. What's "better"? To screw debtors or creditors? To make millions unemployed or to "debase the currency"? Those are very important questions. More important, they're questions that cannot be solved by economics. They can be informed by them, but at the end of the day what you prefer is going to come down to your own moral value system. In other words, it's a political choice. And the way we make political choices in modern countries is through the democratic process, not through unelected, unaccountable technocrats....

The bottom line is that the argument of supercompetence of central bankers is dead and once that's gone you need to revert those powers back to the political process (emphasis in original).

Now, this is a pretty powerful argument.  One would be hard-pressed to say that Jean-Claude Trichet or Alan Greenspan or Ben Bernanke have covered themselves in glory during the past five years or so.  Why not return central banking to the politicians? 

Well.... before I answer, I want to object to Gobry's framing of the issue in two ways.  First, he sets up a too-simple dichotomy between "independence" and "political control."  The devil is in the details here.  Political scientists have done a lot of research into how legislatures exert influence over supposedly "independent" institutions like courts and regulatory agencies, and this logic applies to central banks as well.  Or, to put it another way, I suspect that Ben Bernanke would be pumping more money into the economy were it not for a fear of Congressional blowback.  Furthermore, "political control" is unclear here -- which politicians have control?  Would central bankers be directly elected?  Appointed by the legislature?  Appointed by the executive subject to recall?  And so forth. 

Second, the notion that central banking decisions are strictly political seems as wrong as characterizing them as strictly technical.  It is overly cynical to believe that either technocrats or politicians gin up any old theory to justify the policy ends they seek.  As with Supreme Court disputes, there are genuine disagreements in economics on the theory side.  At this very moment, different central bankers disagree over the best way to reduce unemployment in part because of different economic theories.  Expertise is kinda important in these moments.  

OK, these contestations aside, I still have a basic problem with Gobry's argument.  For Gobry's process to work better, voters have to punish politicians for poor monetary policy and reward them for wise and prudent monetary policies.  I see little evidence that voters would have the necessary knowledge and attention span to do this.  Instead, they would likely vote on other considerations, or vote based on short-term considerations such as the unemployment rate and GDP growth without considering whether short-term pump-priming is occurring or long-term sustainable growth.  Furthermore, politicians would rig the game just a bit.  Political scientists have extensively discussed the existence of "political business cycles" due to fiscal policy. I have every confidence that political control over monetary policy would simply extend the phenomenon to that policy lever as well. 

The fact that politicians still control the fiscal lever is what leads me to think that central banking should still be independent.  A diversification of political controls over the economy seems like the best minimax strategy over the long run.  Thinking back to how U.S. politicians would have handled the last 20 years of central banking, I suspect that they simply would have exacerbated the boom-bust dot-com and housing bubbles.  It's not clear at all that the added democratic gain outweighs the loss in policy competence. 

That said, Gobry makes a powerful argument, and I'd like to hear from readers.  Has independent central banking jumped the shark?  What do you think? 

Daniel W. Drezner

The Flitter Warning

Periodically, Reuters' Emily Flitter files a story on the Sino-American financial relationship that contains great reporting.  Unfortunately, analysts and pundits often take that reporting and misinterpret what it means.  The hardworking staff at this blog hereby dubs this phenomenon The Flitter Warning

Her latest story, which got the Drudge link and was widely linked to, reveals that China no longer has to go through Wall Street to buy U.S. Treasuries:

China can now bypass Wall Street when buying U.S. government debt and go straight to the U.S. Treasury, in what is the Treasury's first-ever direct relationship with a foreign government, according to documents viewed by Reuters.

The relationship means the People's Bank of China buys U.S. debt using a different method than any other central bank in the world....

China, which holds $1.17 trillion in U.S. Treasuries, still buys some Treasuries through primary dealers, but since June 2011, that route hasn't been necessary.

The documents viewed by Reuters show the U.S. Treasury Department has given the People's Bank of China a direct computer link to its auction system, which the Chinese first used to buy two-year notes in late June 2011.

China can now participate in auctions without placing bids through primary dealers. If it wants to sell, however, it still has to go through the market.

The change was not announced publicly or in any message to primary dealers.

Now, this sounds like China is getting some kind of sweetheart deal, or at a minimum preferential treatment in its dealings with the U.S. Treasury, which ruffles the feathers of the easily ruffled.  The Blaze, for example, suggests:  "Considering the fact that China is America’s greatest creditor, as well as the fact that they are becoming increasingly antagonistic in cyber security attacks, maybe – just maybe – granting the Communist country a direct computer link to the treasury auction system isn’t the wisest decision."

A closer look at Flitter's story, however, reveals a more nuanced picture.  First, China isn't getting a direct discount by bypassing Wall Street.  As Flitter notes, "Primary dealers are not allowed to charge customers money to bid on their behalf at Treasury auctions, so China isn't saving money by cutting out commission fees."  On the other hand, China is likely saving some money by keeping Wall Street a little more in the dark about its buying intentions (and thereby preventing traders from driving up the price of securities China intends to purchase). 

Second, and this is really important -- Flitter fails to explain an important strategic reason why the United States might agree to this arrangement.  She proffers two possibilities.  First, that because this financial relationship is so politically sensitive, both sides have an incentive to keep the depths of it under wraps.  Second, U.S. Treasury officials want to make the Chinese purchasers of U.S. debt happy. 

I'd suggest a third -- through this arrangement, U.S. officials now have better data on just how much debt China is purchasing.  For years, Beijing has tried to conceal the extent of its U.S. debt purchases by going through intermediaries in London and elsewhere (see this Setser and Pandey paper for more on the details).  Flitter notes in her story that "in 2009, when Treasury officials found China was using special deals with primary dealers to conceal its U.S. debt purchases, the Treasury changed a rule to outlaw those deals."

This arrangement seems like a win-win deal to me.  China, by bypassing Wall Street, saves a bit on its debt purchases by not moving the market so much.  The United States, by dealing with Beijing directly, gets more accurate information on just how much U.S. debt China is purchasing.  Flitter's reportage, in other words, simply confirms the existence of mutual interdependence between China and the United States, not asymmetric dependence.  Which sounds... awfully familiar

So, let the Flitter Warning go forth -- interesting new facts, but not much to worry about here.