The vote standard: either people want to get rid of inflation or they don't

National Review, June 10, 1991 by Andrew Coyne

AT THE HEIGHT of Lebanon's protracted civil war the governor of the Banque du Liban, the country's central bank, locked himself inside the bank's West Beirut headquarters, with about $5 billion in gold and foreign currencies for company. He did not set foot outside for more than two years, eating, sleeping, and tending his flowers in a small two-room apartment on the top floor. Secure against pillage by either side in his sandbagged redoubt, he issued bank notes, paid interest on government debt, and struggled to support the Lebanese pound. Well, almost secure: last spring, gunmen burst in and tried to abduct the governor. They roughed him up, but were forced to flee when bank guards arrived and opened fire. The minister of finance later issued a public apology. The gunmen, after all, were his.

Few central bankers have had to go to quite such lengths to safeguard their independence from political interference. Yet over much of the industrialized world, they must feel similarly besieged. Hardly a week goes by without one official or another in the Bush Administration badgering the Federal Reserve to ease monetary policy, with notable recent success. In Japan, months of bickering between the finance minister and the governor of the Bank of Japan over interest rates helped set off last year's 50 per cent fall in the Nikkei Dow. Even the famously independent Bundesbank was rudely overruled on the terms of German monetary union by the Kohl government. Central banks are supposed to be autonomous, de jure or de facto, in all of these countries. But you'd never know it these days.

By contrast, in countries where central banks have historically been under political control, the trend is the other way. Public figures in Britain, including former Chancellor of the Exchequer Nigel Lawson, are calling for an independent Bank of England. Newly democratic Chile is the first country in Latin America to establish an independent central bank; Argentina may follow. The countries of Eastern Europe are taking the same step, led by Poland and Hungary. The radical economic liberals in New Zealand's Labor government even went so far as to tie the salary of the governor of the Reserve Bank to his success in fighting inflation.

These competing tendencies met head-on in two bills first introduced in the last Congress. One, sponsored by Representatives Byron Dorgan (D., N.D.) and Lee Hamilton (D., Ind.), would have given the treasury secretary a vote on the Federal Open Market Committee, which sets Fed policy (it was later changed to say the secretary should meet regularly with the committee). It would also require immediate release of the minutes of each meeting, and allow a new President to install his own choice as chairman a year after taking office. The other bill, sponsored by Representative Stephen Neal (D., N.C.), would direct the Fed to cut inflation to zero over five years. Though ultimately unenforceable, a legislative ban on inflation would help immunize the Fed from Washington's vociferous cheap-money lobby.

The same struggle is being played out in Europe. At German insistence, the new European central bank the European Community is contemplating will be given the statutory duty of maintaining the purchasing power of the European Currency Unit (ECU). Policy will be set by a council made up of the governors of the 12 nations' central banks (plus five to seven full-time directors) independently of other EC bodies. At French insistence, however, the council of finance ministers will control exchange-rate policy, which implies control of interest rates. And there is no guarantee of the independence of each country's central bank (though member states are supposed to move toward this)-leaving open the chance of political interference by proxy.

The arguments in these civil wars are always the same. The Roundheads, invoking democratic principle, insist that central banks must be accountable to elected authorities. The Royalists defend the central banks' divine right to set monetary policy independently. Monetary policy, in the Royalists' view, would inevitably lean to inflation if left to the vagaries of democratic politics. A politicized Fed would find it harder to take unpopular but necessary steps to maintain price stability. As the arch-Royalist Economist put it, "Any government that insists on access to the printing press cannot be trusted with it."

Royalists argue that an independent central bank is still accountable, in the end. Central bankers are appointed to fixed terms by elected officials. If the people don't like what they're doing, they can always elect politicians pledged to replace them. The New Republic's Michael Kinsley calls it "democracy on a long fuse." Still, this ought to give democrats some pause. The analogy is frequently drawn with the Supreme Court, which is also "unaccountable." But that's because the Court must often protect minorities from the tyranny of the majority. The implication in the case of the Fed, as Kinsley acknowledges, is that the majority must be protected from itself. This strikes at the heart of democratic governance. Nobody suggests that a similarly appointed agency set tax policy.