Bailey: Central bank independence needs rethinking
Bank of England Governor Andrew Bailey argued that the modern concept of central bank independence (CBI) is incomplete, particularly regarding financial stability. Speaking at Columbia University, he called for further thought on its application beyond monetary policy.
CBI's historical anchors
Bailey traced the origins of modern central bank independence (CBI) to the high inflation era of the 1970s, though noting its longer history.
He cited Henry Thornton's 1802 assertion that the Bank of England was "quite independent of the executive government," reconciled with extensive government lending by "mutual convenience.
" John Locke's 17th-century emphasis on money's stable value also served as an anchor.
Post-1970s, CBI evolved into formal statutory powers, anchored on monetary stability.
The UK system, for instance, grants operational independence to the Bank of England to meet an inflation target set by the government.
This delegation acts as a commitment device, reducing incentives for governments to create inflation for short-term gains, thereby anchoring inflation expectations.
This historical perspective highlights the foundational role of price stability in the development of CBI, setting the stage for its modern application.
The financial stability puzzle
Bailey argued that while the case for CBI in financial stability is similar in principle to monetary policy, its delegation is a less robust contract.
This reflects the broader, less measurable remit of financial stability, defined by the absence of instability across many dimensions and direct engagement with private interests.
Unlike monetary policy's aggregate tools, financial stability involves many levers directly affecting private interests, creating more scope for conflict between public good and private interests.
This tension can lead to pro-cyclicality, with financial stability sometimes neglected before a crisis and then emphasized during one.
This under-discussed divergence in CBI's nature for monetary and financial stability makes financial stability less straightforward to capture in legislation or a single numerical target.
A crucial conceptual gap
Bailey's speech highlights a critical conceptual gap in how central bank independence is applied to financial stability.
This divergence, often overlooked, creates practical challenges and potential pro-cyclicality in policy.
Addressing this requires a more robust framework for financial stability mandates, moving beyond the monetary policy paradigm.