Authors: Adam Triggs and Jake Read, ANU
March 2019 saw Philippine President Rodrigo Duterte move his Budget Secretary, Benjamin Diokno, to govern the central bank. The press was quick to call this a politically motivated interference with the central bank’s independence. The markets were equally quick to shave 1 per cent off the Philippine Peso.
Duterte’s decision follows a common trend — the independence of central banks is being challenged to differing degrees and for different reasons in many Asian countries. These include the Philippines, India, Thailand, Indonesia, Japan, Pakistan, Turkey, Russia, and further afield in the United States.
While weakening the independence of central banks can have dangerous long-term consequences, independence is not a universal panacea. There are times when less central bank independence makes sense. Asian governments must learn the difference.
President Duterte is no fan of high interest rates. Diokno, the new central bank governor, appears to agree. He has historically favoured a weaker currency, strong state spending and sees high inflation as ‘tolerable’ in a growing economy. Having leap-frogged three deputy governors in his appointment, he is tipped to loosen the Philippines’ monetary policy stance and is considering a cut to the 18 per cent reserve requirement on banks.
India has similar challenges. The Reserve Bank of India (RBI) made headlines in late 2018 when then governor Patel resigned prematurely. The resignation was allegedly due to his refusing government demands to lower interest rates, let state banks increase their power and lending, and to allow the government access to RBI reserves. Patel was quickly replaced with Prime Minister Modi’s former secretary of economic affairs and G20 sherpa, Shaktikanta Das, who announced a 25 basis point cut to the benchmark repo rate. Modi approved — Das then announced another one.
There is a similar pattern across Asia. The Thai finance ministry has publicly traded barbs with the central bank over the direction of interest rates. The Indonesian parliament passed the ‘Prevention and Resolution of Financial System Crisis Law’ in 2016 that, among other things, weakens the autonomy of Bank Indonesia in managing financial crises. In 2013, the Bank of Japan agreed to coordinate its policies with the government — many saw this to be an alarming attack on its independence.
Further afar, President Erdogan criticised Turkey’s central bank for increasing interest rates to reduce inflation, and then claimed the power to appoint the bank’s rate-setters and put his son-in-law in charge of economic policy. We see similar pressures in Pakistan, Russia and the United States where President Trump says he is ‘not even a little bit happy’ with Jerome Powell.
A longer view shows that central bank independence has increased significantly since the 1980s, particularly in emerging economies. But these recent developments could represent the start of a reversal in this long-run trend. Should we be worried?
The seminal paper on central bank independence came from Alberto Alesina and Larry Summers in 1993. It showed that industrialised countries with independent central banks enjoyed lower inflation. Other studies confirmed these findings for advanced and emerging economies using more recent data.
The IMF shows that central bank independence is correlated with lower inflation, improved transparency and higher institutional quality. Jon Simon and Olivier Blanchard show that central bank independence lowers the volatility of GDP and inflation. Gaston Gelos and Yulia Ustyugova found that commodity price shocks have less persistent effects in countries with independent central banks.
But central bank independence exists on a spectrum. Pure-independence may not always be a good thing.
Guy Debelle and Stanley Fisher suggest that central bank independence can follow two models: ‘goal independence’ where the central banker has autonomy over its goals and policy instruments (such as the Federal Reserve or European Central Bank), or ‘instrument independence’ where the central bank sets a policy instrument in pursuit of a goal specified by the government (such as the Bank of England).
The evidence suggests that the operational independence of central banks has significant economic benefits, but the full political independence of central banks appears uncorrelated with economic outcomes.
Adam Posen warns that ‘the impact of central bank independence on economic outcomes is highly overrated’. Larry Summers notes that when the challenge is to increase (not decrease) inflation, more cooperation between central banks and finance ministries is better than less. Willem Buiter argues that the responsibilities and tools that central banks have accumulated, such as macroprudential tools, have made their independence more difficult.
This paints a complex picture for Asia. For countries struggling to increase inflation and boost growth, better cooperation between fiscal and monetary policy may well improve economic outcomes. This may well be important to policy outcomes in Japan. Policy cooperation should not be opposed on the altar of central bank independence if it improves economic outcomes.
Yet there remains no justification for politicians pressuring central banks into using monetary policy instruments to achieve short-term political objectives, as in the Philippines, India and Thailand. History shows this is a dangerous path to tread.
Adam Triggs is Director of Research at the Asian Bureau of Economic Research in the Crawford School of Public Policy, the Australian National University, and a non-resident fellow at the Brookings Institution.
Jake Read is a research student at the Asian Bureau of Economic Research in the Crawford School of Public Policy, the Australian National University.