Central banks under fire

Policy punchbags

From Argentina to America, politicians are taking aim

RICHARD FISHER, president of the Federal Reserve’s Dallas regional bank, did not hold back. Invoking the hyperinflation of Weimar Germany and Zimbabwe, he warned on January 12th that for Congress to tamper with the Fed’s independence would lead “directly to economic ruin.”

This is hyperbole, to be sure, but the threat of political meddling with independent central banks is genuine, and not just in America. This may seem unsurprising. Stressful economic times almost invariably fuel political support for inflationary policies. Yet the latest stand-offs between central banks and politicians in places as far afield as Argentina, Japan and South Korea do not yet fit this pattern. And some central banks have left themselves vulnerable because of a failure to maintain stable prices or a stable financial system.

The most fiery clash has been in Argentina, where the president, Cristina Fernández, tried to fire the central-bank governor, Martín Redrado, earlier this month for refusing to transfer $6.6 billion in foreign-exchange reserves to the government. Mr Redrado has refused to budge, saying that Congress has approved neither the transfer nor his dismissal.

Mr Redrado’s own record is not perfect. Since the collapse of Argentina’s currency board in 2002, the central bank has focused more on steadying the peso than on stabilising prices. Inflation, below 5% when Mr Redrado took office in 2004, may now be 15%. Eduardo Levy-Yeyati, a former chief economist at the central bank, says Mr Redrado could have run a tighter policy. But his task has been complicated by politically dictated changes to the consumer-price index, which puts inflation at about 7%. Mr Redrado also argues that inflation is primarily caused by loose fiscal policies.

Ms Fernández’s tactics will only undermine the central bank’s autonomy and make it harder to rein in inflation and inflation expectations. That may now require the central bank and government to agree on an inflation target and a plan of wage and price co-ordination to meet it, says Mr Levy-Yeyati.

In South Korea President Lee Myung-bak has bluntly implored the Bank of Korea to go slow in returning interest rates, now 2%, to more normal levels. To make the point more directly, the vice-minister of finance attended the bank’s policy meeting on January 8th. That is the government’s right, but one it had not chosen to exercise since 1999.

By most criteria, the bank has handled itself well lately. Inflation is below the 3% midpoint of its target range and last year’s economic downturn was relatively mild. The governor, Lee Seong-tae, has indicated that he wants to return rates to normal soon. The government’s actions will raise questions over how steadfast the bank can remain, although it fuelled concerns itself in November by widening its inflation-target range to between 2% and 4%. The old range was 2.5-3.5%.

In Japan deflation is the problem. Since the Democratic Party of Japan took office last year, it has been pressuring the Bank of Japan to be fiercer in fighting deflation. Despite the clumsiness of its tactics, the government’s concerns are legitimate. Japan has been mired in deflation for a decade, and prices are falling by 2% year on year.

The Bank of Japan has kept interest rates close to zero but remains otherwise oddly reluctant to take stronger action. Some outsiders believe it maintains an excessively tight policy as a way of asserting its independence, which it won at around the time deflation took hold. Its resistance, however, seems to be weakening. Shortly after Naoto Kan, then the deputy prime minister and now also the finance minister, gave a noisy warning of deflation’s threat late last year, the bank adopted a new lending facility to boost the money supply and bring down money-market rates.

In America, although the Fed enjoys the solid support of Barack Obama, it is under intensifying attack in Congress. One proposal would subject the Fed’s monetary-policy decisions to congressional audit while another would make the presidents of the 12 semi-autonomous regional reserve banks politically more accountable. The Fed’s inflation record is good and its response to the crisis has been creative and bold. But it has left itself open to attack by demanding more oversight of the financial system when critics say it did not make good use of its existing powers to supervise banks and enforce consumer-protection laws before the crisis.

The latest round of meddling does not so far signal a more decisive rejection of the merits of independent central banks. Nor does a new outbreak of high inflation seem imminent, given the pervasive deflationary conditions in most of the rich world. But politicians still need to be careful. Their attacks could ultimately backfire if they undermine investor confidence and push up long-term interest rates.