Around the democratic world, there is a power struggle taking place that might end up being the most damaging and long-lasting consequence of this era of populism. Elected leaders — from Donald Trump to Turkey’s Recep Tayyip Erdogan to India’s Narendra Modi — have been steadily attacking the independence of their nations’ central banks. This could end very badly.
A brief history of modern central banking. As The Economist points out, politicians in the 1970s would routinely use central banks to goose the economy before elections to help them win. This helped create a wave of inflation that paralyzed economies and caused untold misery. The middle class saw its hard-earned savings evaporate within a few years.
As a result, over the last three decades, countries around the world have given central banks much greater independence. The United States was one of the leaders in this regard, with Paul Volcker asserting the Federal Reserve’s independence and breaking the back of the “stagflation” that had crippled the American economy in the 1970s.
Today, it is Trump who is leading the charge in the opposite direction. He is attacking the Federal Reserve and asking it not only to cut rates but to actually engage in emergency measures to boost the economy — at a time of robust growth and low unemployment. To ensure that the Fed complies with his wishes, he has considering nominating two candidates to its board whose only qualification appears to be a slavish devotion to the president.
But Trump is not alone. Last year, Erdogan issued a sweeping presidential decree allowing him to directly appoint Turkey’s central bank leadership. And in March, the country’s central bank spent a staggering $2 billion trying to prop up the Turkish lira in advance of local elections.
In India, Modi pushed out two central bank governors so that he could find a more pliable one. He has succeeded. In February, the bank cut rates, apparently to help him in the national elections that are now underway. In addition, and more extraordinarily, he essentially raided the central bank’s coffers for $4 billion to buy the votes of poor farmers.
In South Africa, the ANC is moving to change the structure of its central bank, long private and fiercely autonomous. In the Philippines, the president appointed a close political ally to head the bank. And even in Europe, populists now routinely target their central banks. The Italian governing coalition has been attacking the central bank’s leadership and questioning whether the bank should really be the steward of $100 billion of gold reserves. That could be the start of an effort to raid the country’s gold reserves to give the economy a short-term sugar high.
To get a sense of how much the intellectual mood has changed, consider this: Alan Blinder — a Princeton economics professor who had served as vice chair of the Federal Reserve Board of Governors — wrote an essay in 1997 arguing that the Fed was so obviously successful at policymaking that the government should adopt that model in other areas, like tax policy. He advocated the use of independent agencies and commissions to shield policy from the overt political influence of elected officials, who would want to manipulate policy for short-term advantage.
Today, Trump wants the opposite. He would like to infuse the short-term passions of partisan politics into the Federal Reserve. Trump senses that the country’s mood has changed. The financial crisis and the bank bailouts have eroded the Fed’s credibility. And it’s not just in America — across the world, central banks are seen as having failed to rescue Main Street while being too solicitous of Wall Street.
Some of this criticism is justified, though not in the United States, where the actions of the Fed and the Bush and Obama administrations worked better than anywhere else. That’s why the American economy recovered fastest, and its financial sector is now stronger than any other major economy. But even where the critique has merit, the solution should not be to destroy the entire institutional structure of central bank independence.
The assault on central banks will not have an immediate effect. But over time, their credibility will be eroded, their effectiveness will wane, and then one day, when the next crisis hits, we will all wish we had institutions that could weather the storm. But by then, it will be too late.
Fareed Zakaria’s email address is fareed.zakaria.gps@turner.com.
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