Is political immunity for central banks necessary?
Central bank independence is a cornerstone principle of modern economic policy. Numerous arguments support the idea that monetary policy decision-making should be separated from day-to-day political influence. However, the demand for democratic accountability and economic policy coherence occasionally tips the scales towards closer political control. Finding the optimal balance between these two approaches is a complex task that can result in different solutions depending on the country and historical context.
The most important argument for central bank independence is the preservation of credibility. If the central bank’s decisions are not influenced by short-term political goals, such as attempts to stimulate the economy before elections, then market participants will have greater confidence in the central bank’s commitment to price stability. This trust is crucial for keeping inflation expectations low, which ultimately can lead to lower actual inflation. Political intervention can jeopardize the central bank’s long-term objectives and cause instability in financial markets.
Another important argument emphasizes expertise. Central banks typically employ highly trained economists and financial experts who possess in-depth knowledge of economic processes and monetary policy tools. Political decision-makers, on the other hand, consider a broader range of factors and do not necessarily have the same level of professional knowledge in the field of monetary policy. Independence ensures that monetary decisions are made on a professional basis, with the best available knowledge.
Historical experiences also support the benefits of central bank independence. Numerous studies have shown that countries where central banks have a greater degree of independence generally achieve lower and more stable inflation. Political influence can weaken the central bank’s resolve to implement strict monetary policy, especially when it involves unpopular measures such as raising interest rates to curb high inflation.
Central bank independence also provides protection against fiscal dominance. Fiscal dominance occurs when the government accumulates excessive budget deficits, and the central bank is forced to monetize this deficit, i.e., create new money to finance government debt. This can lead to inflation and undermine the central bank’s price stability objective. An independent central bank is able to resist political pressure to monetize the budget deficit, thereby preserving the integrity of monetary policy.
However, arguments can also be made for closer political control. Perhaps the most important is the principle of democratic accountability. Central banks are important public institutions that have a significant impact on the economy and people’s lives. In a democratic system, it is expected that these institutions should be accountable in some way to elected representatives. Complete independence can mean that the central bank’s decisions cannot be directly influenced or overridden by democratically elected bodies, which some argue can undermine democratic legitimacy.
Another argument is the need for economic policy coherence. Monetary policy does not operate in a vacuum but interacts closely with the government’s fiscal policy and other economic policy measures. Closer political control could theoretically allow for better coordination of monetary and fiscal policy, leading to more effective economic management. For example, during an economic crisis, the government may implement stimulating fiscal measures, and a central bank under closer political influence could support these measures with loose monetary policy.
Furthermore, it can be argued that central bank decisions should also take into account social and employment considerations, not just price stability. Political decision-makers, who are directly responsible to the electorate, may better represent these broader social interests than an independent central bank focused solely on monetary stability.
In the case of the Magyar Nemzeti Bank (MNB), the issue of central bank independence has become particularly prominent in recent years, partly due to the foundations it established. In 2014, the MNB created six public interest asset management foundations known as the Pallas Athéné Foundations, which received significant amounts of public funds from the central bank’s profits. This move sparked considerable debate about the boundaries of central bank independence and accountability.
According to the MNB’s leadership at the time, the purpose of establishing the foundations was to support economic education and research, as well as to increase financial literacy. However, critics raised concerns that the control over the foundations was not transparent, and the use of public funds was not sufficiently accountable. Concerns were also raised that through the foundations, the central bank was financing activities that do not necessarily fall within the traditional tasks of a central bank, and that this withdrawal of assets could weaken the central bank’s financial position.
The Pallas Athéné Foundations case highlighted that central bank independence extends beyond the monetary policy decision-making process to the management of the central bank’s assets and other activities. Critics argued that the establishment and operation of the foundations violated the spirit of central bank independence, as decision-making over public funds was not transparent and not subject to direct political accountability. In addition, the question arose whether the central bank had the authority to establish and finance such foundations.
The State Audit Office (ÁSZ) also conducted an investigation into the MNB’s foundations, and the publicly available information suggests that it found significant deficiencies and irregularities in asset management. This further strengthened the voices calling for closer political control of the central bank, at least with regard to its non-monetary policy activities.
Finding the optimal balance between central bank independence and political control is a constant challenge. Complete independence can jeopardize democratic accountability and economic policy coherence, while excessive political influence can undermine the central bank’s credibility and threaten price stability.
The Hungarian example, particularly the case of the MNB’s foundations, illustrates that the concept of central bank independence needs to be understood in a broader context. It does not only mean the immunity of interest rate decisions from political influence but also the transparency and accountability of the central bank’s entire operation, including asset management and non-monetary policy activities.
In the future, the debate about where the correct boundary lies between central bank independence and political control will likely continue. Analyzing international best practices and domestic experiences can help in finding a model that best serves the stability of the Hungarian economy and the realization of democratic principles. This requires open and constructive dialogue between political decision-makers, central bank experts, and the public. The goal is to develop a central bank operation that is both independent of short-term political pressure and accountable to society.