Independence Lost

TILBURG – Every major economic crisis has its victims. Some bounce back, while others experience long-lasting, even permanent, damage. When it comes to the global crisis that erupted in 2008, output growth has been a resilient victim. Central bank independence, by contrast, has been undermined severely – and possibly forever.

In the 1970’s, the Western world was confronted with a unique phenomenon: simultaneous recession and rising inflation. Germany’s success in maintaining low inflation in this environment was explained by the fact that the Bundesbank was de facto independent from the German government. This triggered a global movement, in which country after country adopted legislation to increase the independence of its monetary authority. Soon, inflation began to fall.

With rapid economic growth leading to lower-than-expected outlays and higher-than-expected income for Western governments, maintaining central banks’ independence from political pressure was easy. Governments did not need their central banks to print money.

But, in a less favorable economic climate, printing money becomes a handy alternative to difficult decisions and painful adjustments, such as tax hikes and deep cuts in government spending. Indeed, since the onset of the ongoing financial and sovereign-debt crisis, advanced-country governments and central banks have allowed fiscal policy to prevail over monetary policy.