Apolitical Money – An Illusion?

3.1 Independence

At the time when the heads of state and government agreed in Maastricht on the statute of the future European central bank and on its independence, only the Bundesbank was completely independent. All other national central banks were, to a greater or lesser degree, dependent on decisions made by their governments.

As previously mentioned, lessons learned from the historical development of inflation supported the case for independence. To what extent the governments were convinced by the scientific evidence remains an open question. There is one crucial factor for the quick agreement on this issue. For the German side, this point was non-negotiable. Given the high esteem in which the German public held the Bundesbank and its currency, the D-Mark, and the great scepticism on the flip side towards a future common European currency, it seems unlikely that any German government could have signed a treaty without the present statute and the central bank independence enshrined therein.

In general, it is difficult to gauge what status central bank independence enjoyed in the other countries at the time. The range most likely extended from full support to considerable reservations, if not rejection.

Looking at the sceptical side, one statement stands out from then French President François Mitterrand after (!) the signing of the Maastricht Treaty and shortly before the French referendum on its adoption.

“La Banque Centrale, la future Banque Centrale … elle ne décide pas … Les techniciens de la Banque Centrale sont chargès d’appliquer dans la domaine monetaire les décisions du Conseil Européen, prises par les douze Chefs d’Etat et de Gouvernement, c’est-à-dire par les politiques qui représentent leurs peuples … Or, j’entends dire partout … que cette Banque Centrale Européenne sera maîtresse des décisions! Ce n’est pas vrai! La politique monétaire appartient au Conseil Européen et l’application de la politique monétaire appartient à la Banque Centrale, dans le cadre des decisions du Conseil Européen” (Debate on French TV on September 3 1992).

Institutional economics has developed criteria for the acceptance of formal institutions and their stability (Richter and Furobotn 2003). According to these criteria, attempts to impose a constructed institutional framework on a society cannot be expected to succeed in the long term. Institutions continually rest on experience. This results in a certain path dependency for political decisions.

Depending on how the Maastricht Act was received in those countries that later became members of the monetary union, a lack of implicit consent on the independence of the future European central bank in the societies of the member countries places a heavy burden, in certain cases, on the ECB.

The ECB therefore faced a difficult challenge from the very beginning. On the one hand, it had to maintain and strengthen confidence in its independence. On the other hand, it had to win people over with its policy in countries where this trust had not yet been sufficiently developed. This task is rendered all the more difficult by the diversity of the states in the euro area along multiple dimensions. Last but not least, the numerous languages of the member states pose a great challenge in communication.

This heterogeneity in the euro area extends far into society and goes way beyond attitudes to the central bank and its independence. The differences deeply rooted in national cultures have long impeded, if not blocked, the path to monetary union. The Maastricht process led to a rapprochement, but old differences resurfaced during the financial crisis (Brunnermeier et al. 2016). Developments since then do not suggest that the problem has substantially subsided in the meantime. This scepticism is not least evident in the national origin of attacks on the ECB and its decisions.

3.2 Appointment of the Central Bankers

The status of independence opens up a wide scope in the policy of central bank leaders under the paper standard. Liberal economists have always perceived the danger posed here by unsuitable or even incompetent central bankers (Eucken 1955; Simons 1936). The attempt to bind the actions of central bankers by means of a strict rule for monetary policy laid down by law must be considered a failure. The proposal put forward by Rogoff to appoint “conservative persons” (Rogoff 1985) has remained an interesting idea. A number of methods exist for appointing those in charge. The government or the parliament are the first to be considered. The competence resides with the politicians. Clearly, this provides a gateway for the independence of the central bank to be politically undermined. With a long guaranteed term of office and a bar on reappointment, certain precautions exist to strengthen personal independence. Under such a regime, policymakers also cannot be sure that the person selected will prove immune to political influence once appointed. This is more likely to be the case if the decision-making body shows strong consensus on stability orientation and the newly appointed person subscribes to groupthink in a kind of “Beckett effect” (Issing 1993).

In the end, the general attitude towards the independence of the central bank in a country is decisive when it comes to the criteria politicians use to appoint central bankers.

3.3 The Mandate

Shifting responsibility for such an important task as monetary policy to an institution that is independent of the political process, and thus removing it from parliamentary control, contrasts with fundamental principles of democracy. The decisive argument for this decision, an act of “self-disempowerment of parliament” (Schmidt 1973), lies in the historical and also theoretically justifiable experience with protecting against politically induced inflation. In his statement of 20 May 1997, then British Chancellor of the Exchequer Gordon Brown justified why the government was granting independence to the Bank of England: “The previous arrangements for monetary policy were too short-termist, encouraging short but unsustainable boom and higher inflation, followed inevitably by recession. This is why we promised in our election manifest to … reform the Bank of England to ensure that decision-making on monetary policy is more effective, open, accountable and free from short-term political manipulation” (Statement of May 20 1997). Independence needs to be limited by a clear mandate. Price stability lends itself to this function as the genuine task of monetary policy. A dual mandate, as in the case of the Fed with price stability and maximum employment, charges the central bank with the duty to weigh these goals politically under certain circumstances.^[1]

In financial stability, central banks have a task they cannot avoid, regardless of whether or not a legal obligation applies (Issing 2017a). In performing this task, a central bank repeatedly runs the risk of conflicts with its primary objective of price stability. Under these circumstances, discussions about reputation and independence are bound to arise. The situation is similar when the central bank is assigned the task of banking supervision and potentially also macroprudential policy.

This accumulation of tasks must lead to questions about the limits of a central bank’s independence. All the more so when a central bank, on its own initiative and/or under public pressure, commits itself to additional goals. The distribution of income and wealth are the primary candidates to consider here. Monetary policy inevitably has distributional effects. It is an entirely different case, however, if the central bank specifically pursues distributional policy goals.

As climate change takes on ever greater significance, on the one hand politicians and the public are pushing for central banks to play their part in tackling this problem. On the other hand, a number of central banks have themselves announced that they will take the problem of climate change into account in their policy decisions or even give it a prominent role.

It is inevitable that the expansion of objectives raises pressing questions about the justification of independence and its limits. It must also be considered that the central bank is placing its credibility at risk if it becomes overburdened by these additional tasks. The associated loss of credibility is bound to damage the public’s acceptance of central bank independence (Issing 2022, 2017b).

By extending their measures into areas that, in a democracy, must be reserved for politics, governments and parliaments, central banks themselves provoke concerns about the status of their independence. This also holds true because the additional objectives are destined to come into conflict with their primary goal of price stability.

3.4 Danger of Fiscal Dominance

With the massive purchases of government bonds known as quantitative easing, central banks have trodden or even overstepped the boundary of fiscal policy. The more substantial these interventions are, the more difficult it becomes to distinguish the effects – whose macroeconomic successes are disputed – from the monetary financing of public budgets. It is therefore not surprising that so-called Modern Monetary Theory (MMT), which seeks to make a virtue out of this dilemma, notwithstanding its fundamental flaws has found such favour (Issing 2020). The higher the national debt, the greater the impact of interest rate hikes on public budgets. This raises the political pressure on central banks to abandon or at least weaken a monetary policy geared to monetary stability. The Fiscal Theory of the Price Level (Cochrane 2023) provides a theoretical framework that allows to study fiscal dominance. This theory shows that a government with an irresponsible fiscal policy can enforce inflation on the economy irrespective of the independence and interest rate policy of the central bank.

For the ECB, the institutional constellation – one central bank, 20 public budgets and sovereign debtors – presents an additional, eminently important problem. With the “whatever it takes” of 2012 by then President Draghi and the announcement of the Outright Monetary Transactions (OMT) programme, the central bank has assumed responsibility for the cohesion of the euro area in its current composition. The ECB has since reinforced this commitment by announcing the Transmission Protection Instrument (TPI) programme (Issing 2022). With the self-imposed obligation to save, if necessary, highly indebted member states from a rise in government bond interest rates that is deemed unacceptable, the central bank is taking on a responsibility that must be reserved for the governments of the member states, for politics. This casts doubt on the status of independence, regardless of how the supreme courts rule.