The Day After Russia Attacks
What War in Ukraine Would Look Like—and How America Should Respond
In January, a new leading actor strode onto the world stage. More powerful than most national governments and responsible for helping to set the economic and political course for 280 million people and almost a quarter of the global economy, the European Central Bank (ECB) is notable for something more sinister as well -- its almost complete freedom from democratic oversight and control.
The ECB represents the culmination of two trends: European integration and central-bank independence. But while the potential drawbacks of the first trend have been analyzed endlessly, those of the second have gone almost entirely unremarked. Leaving central banks undisturbed by their host governments has become an integral part of the neoliberal catechism. In fact, however, the case for removing such powerful institutions from democratic oversight is unproven. Allowing it to rest unchallenged both damages democracy and begs important questions about who the winners and losers of economic policy should be.
The ECB will be responsible for setting interest rates and managing Europe's new currency, the euro. The bank's decisions will affect economic development across an entire continent and help determine whether European integration succeeds. Yet the officials who make these decisions will not have to answer to the publics whose jobs and quality of life hang in the balance. The bankers will not even have to give Europeans much basic information on how and why bank decisions are made. To make matters worse, the bankers' priorities are essentially set in stone; the Maastricht Treaty itself gives the ECB the narrow mandate of keeping prices stable.
All this runs counter to a recent and much-vaunted global trend: the transfer of power from authoritarian elites to democratic publics. Few have protested this inconsistency, however. In a perverse twist, the insulation of central banks from popular control has become one of the chief contemporary signifiers of liberalism. In a secular version of Lent that is now the rage from Europe to Latin America to the post-Soviet bloc, democratic governments are proving their faith and virtue by giving up something dear -- the ability to control their countries' economic destinies.
Exemplifying this trend, more countries increased the independence of their central banks during the 1990s than during any other decade since World War II. The wave swept five continents, engulfing countries as diverse as Albania and Sweden, Kazakhstan and New Zealand. Crucial support has come from an ideological consensus among the world's business and economic elites. The Financial Times, for example, has argued that the arguments "for central bank independence appear overwhelming," while The Economist has declared that "The intellectual case for independent central banks [has been] more or less won." Yet the arguments used to justify removing monetary policy from democratic control do not survive close scrutiny.
NO FREE LUNCH
Advocates of central-bank independence defend it in two related ways. The first is theoretical and justifies treating monetary policy differently from other kinds of policy because of its supposed special characteristics. The second is practical and justifies treating monetary policy differently because so doing supposedly produces important economic benefits. Neither argument holds up.
According to supporters of central-bank independence, monetary policy cannot be entrusted to normal policymaking processes because it is complicated and requires a disciplined, long-term perspective to succeed. Since ordinary people and politicians cannot understand the intricacies of what central banks actually do, the argument goes, they cannot adequately weigh particular policy choices. They are also unable to think far into the future or accept pain now for gain later. (This latter point relates to what economists refer to as the "time inconsistency" problem.) So decision-making in this area needs to be handed over to wise men who will do for the people what they cannot do for themselves. As Alan S. Blinder, a Princeton economist, recently put it,
"First, . . . monetary policy is a somewhat technical field where trained specialists can probably outperform amateurs from the political realm. Second, the effects of monetary policy take a long time to filter through the economy, so good policy decisions require patience and a long time horizon -- two attributes not normally associated with politicians. Third, the pain of fighting inflation (higher unemployment for a while) comes well in advance of the benefits (permanently lower inflation). So short-sighted politicians with their eyes on elections would be tempted to inflate too much."
At first glance, these arguments appear plausible. Monetary policy is indeed complicated and confusing; politicians and publics do often view it with a short-term perspective; and political actors do frequently shrink from prescribing bitter medicine for fear of paying an electoral price. But these qualities characterize almost all policy areas. Indeed, the more important an issue is, the more likely these conditions are to hold. Isn't health care incredibly complicated? Who really is qualified to decide how much funding should go to different types of medical research? Does anybody truly believe that members of Congress or their constituents fully understand the various plans being bandied about for changing Social Security? How many Americans even understand how the present system works? Presumably most would agree that decisions about something as important as Social Security should be made to benefit all Americans rather than a narrow lobby like the American Association of Retired Persons. Add welfare reform, tax policy, foreign policy -- the list is endless. The sad fact is that policymaking in countless areas is often driven by short-term considerations or by the needs of powerful but parochial special interest groups. Monetary policy is simply not that distinctive and need not be treated differently. Blinder is honest enough to admit this squarely and bold enough to ask whether much national policy should not therefore be delegated to independent technocrats. Anyone unwilling to go so far should be prepared to let monetary policy be just as subject to democratic control as everything else.
The second rationale for central-bank independence is strictly practical. Such independence, we are told, produces better overall economic outcomes. In return for freedom from political control, central bankers will provide their societies with major, widespread economic benefits -- in theory. But here too the evidence is unconvincing. Reflecting an almost universal finding, Alberto Alesina, a Harvard political economist, and Lawrence H. Summers, his erstwhile colleague turned deputy treasury secretary, noted in a 1993 survey that central-bank independence "has no measurable impact on real economic performance." In plain English, taking control of a country's central bank away from politicians and giving it to technocrats is likely neither to raise economic growth nor to lower unemployment.
The sole area where Alesina, Summers, and others have detected a possible boon from central-bank independence is in fighting inflation. Even this finding, however, is not as powerful as it appears at first glance. To begin with, the strength of the correlation between central-bank autonomy and lower inflation depends on the criteria used to measure independence, the time period chosen, and -- especially -- the countries included in the sample. If one looks at developing countries as opposed to advanced industrial ones, the positive impact of central-bank independence on inflation simply disappears. This should hardly be surprising, both because politics in developing countries is often guided by informal rules rather than laws and formal procedures and because such countries lack the range and depth of institutions necessary for full policy implementation and coordination. Even in advanced industrial countries, where the correlation between central-bank independence and lower inflation seems strongest, the case is not clear-cut. Some argue, for example, that the correlation is spurious. Thus Adam Posen of the Institute for International Economics claims that "differences in central bank autonomy and reputation are not the sources of inflation differences among the advanced industrial countries. . . . [A]ll the published arguments used to trace a causal link between [central bank independence and low inflation] are not borne out by economic reality." What really matters in the long-term struggle against inflation, Posen finds, is a strong financial sector that is interested in price stability and that is willing and able to influence policymaking to get it. Central-bank independence and lower inflation, in this view, are linked not because one causes the other but rather because both are caused by the political effectiveness of a particular coalition of interests.
Other scholars have come to similar conclusions, noting that independent central banks have little positive long-term impact on inflation unless backed by a societal consensus on the need for stable prices. Students of Germany, for example, have argued that the real source of the Bundesbank's effectiveness is not its statutory independence but rather widespread public acceptance of the need to make fighting inflation a primary economic-policy goal.
The evidence about the economic impact of central-bank independence, therefore, is decidedly mixed. Such independence has not been shown to produce higher growth or lower unemployment, and its effect on inflation is debatable. Moreover, during economic downturns, independent central banks may actually make things worse. Many studies have, for example, linked greater central-bank independence to larger drops in output during recessions. Furthermore, as the economists Sylvester C. W. Eijffinger and Jakob De Haan note, "most studies suggest that central bank independence is associated with higher disinflation costs." In light of all this, one might think that economists and other elites would pause before insisting that central-bank independence is indispensable. Yet the opposite is true. Seizing on the fact that central-bank independence is on average associated with lower inflation (which most advocates of independence cherish) but has few apparent effects (and therefore costs) in other economic areas, economists have concluded that, in the words of Vittorio Grilli, Donato Masciandaro, and Guido Tabellini, "having an independent central bank is almost like having a free lunch." But as economists more than anyone else should know, there is no such thing as a free lunch.
IT'S THE DEMOCRACY, STUPID
What has been overlooked in the rush to make central banks independent is the fact that such political insulation does come at a price -- although not the kind easily measured by slide rules or calculators. By turning over monetary policy to unelected and often unaccountable technocrats, countries surrender much control over their economic fates. Even if the practical benefits of doing so were clear, abdicating such authority would be a grave decision, worth taking only after full national debate. Since the benefits are at best questionable, fully insulating monetary policy from government control regardless of the particular national or economic context could have dire consequences.
The great conceit of the early post-Cold War era was that all good things came together in one package: Free politics (democracy) and free markets (capitalism) were complementary, and the formula for lasting success was open to all. As the world economy has faltered in the late 1990s, however, many have begun to think that these two halves of the liberal order may in fact pull in opposite directions. In both developed and developing countries, more and more people see globalization as a threat and believe they are paying too high a price to satisfy the demands of international capital and finance. Given this backdrop, additional and largely unnecessary losses of popular sovereignty would be counterproductive or even dangerous.
Globalization has played a large role in convincing many countries to free their central banks from political control. Powerful financial and business elites have a greater interest in conservative monetary policy and price stability than other groups like workers, and countries have crafted policies to satisfy the demands of highly mobile international and domestic investors. As Sylvia Maxfield of the Harvard Institute for International Development has put it, "Foreign investors read central bank independence as a signal of the strength of domestic proponents of sound monetary policy, both within the government and among domestic interest groups, with whom the investors might implicitly or explicitly ally in an effort to influence policy."
This type of dynamic is hardly restricted to developing countries; concerns about credibility drove the decision to make the ECB the most independent central bank in the world. The extreme independence of the ECB is meant to reassure financial and business elites that price stability will trump other economic goals and that Europe's economic policy will be appropriately insulated from the demands of labor and other domestic interest groups. The decisions to free Europe's central bank from political control and to focus narrowly on fighting inflation, in other words, were not "technical" or "apolitical," as most advocates of independence argue. Rather, as with all difficult policy choices, they involved painful tradeoffs that will benefit some more than others.
The plans for the bank were drawn up during a period of low inflation combined with rising unemployment and slow growth in Europe -- hardly conditions under which an unprecedented degree of central-bank independence and a narrow focus on price stability are obviously correct prescriptions. An increasing number of European politicians have argued that broadening the mandate of the ECB to include growth and employment would help increase the bank's legitimacy -- and that of the European Union more generally -- without reigniting inflation. Yet these concerns are scorned rather than scrutinized because the Maastricht Treaty states that the ECB cannot seek or take instructions from any EU member government. Wim Duisenberg, the ECB's head, recently remarked that while it was "normal" for politicians to voice their thoughts about monetary policy, it would be "abnormal if those suggestions were listened to." Worse, the ECB's statutes and mandate can be modified only by the unanimous consent of all member states. Even the mighty Bundesbank does not enjoy such freedom; the law governing it can be changed by a simple parliamentary majority.
Adding insult to injury, the ECB's regulations require practically no transparency at all. While developing nations are being told by the West that openness and transparency are indispensable elements of well-functioning modern economies, some of the most advanced industrial nations are walling off crucial economic decision-making processes from public scrutiny. As Joseph Stiglitz, the chief economist at the World Bank, has noted, "transparency -- openness -- is now recognized as a central aspect of democratic processes. There cannot be effective democratic governance without information. Yet central banks continue to operate in secrecy." There are clearly some good reasons for closed deliberations, such as the difficulties of governing the eurozone collectively if national central-bank governors' positions on sensitive topics were revealed. But the existing setup smoothes the bankers' dealings with one another at the expense of public trust. It will also exacerbate tensions between European monetary policy and national economic policies and cycles.
As Talleyrand famously remarked of a Napoleonic-era covert action, this is worse than a crime, it is a blunder -- and a blunder that may well come back to haunt the advocates of European unity who pressed so hard for the ECB in the first place. European integration has thus far been primarily driven by elites. European publics have been skeptical about losing sovereignty and about the generally undemocratic nature of European institutions. The ECB will be one of the most important of these institutions, and its decisions will have major consequences for Europe's economic and political life. Even when times are good, some people will pay significant costs because of choices the ECB makes; when times are bad, the some will become the many, and anger will grow. If the bank's decision-making processes were reasonably transparent and open to democratic oversight, the pain could perhaps be explained and justified. Under the current regime, however, bitter and restive publics may get nothing but dismissive hauteur. The result will be further widespread alienation from the entire European project.
What advocates of the ECB in particular and economists in general seem to have forgotten in the rush for economic efficiency is the power and import of democracy. The essence of democracy is not primarily the outcomes it produces but the process by which those outcomes are reached and legitimated. True democrats believe that government should be not only of and for the people but also by them. Even the most thoughtful advocates of central-bank independence seem to have forgotten this -- something captured by the tone Blinder uses to describe the differences between decision-making at the Council of Economic Advisors and at the "apolitical" Federal Reserve. In the former, he writes,
" . . debate quickly turns to such cosmic questions as whether the chair of the relevant congressional subcommittee would support the policy, which interest groups would be for it and against it, . . . [and how it] would play in Peoria. . . .
At the Federal Reserve, on the other hand, . . . policy discussions are serious, even somber, and disagreements are almost always over a policy's economic, social, or legal merits, not its political marketability. . . . The attitudes of particular legislators, interest groups, or political parties toward monetary policy are rarely mentioned, for they are considered irrelevant.
Such disdain for democratic policymaking has familiar echoes. Tocqueville famously questioned America's ability to conduct a successful foreign policy because of the tendency of a democracy to "obey its feelings rather than its calculations and to abandon a long matured plan to satisfy a momentary passion." George F. Kennan went so far as to advocate the "use of the principle of professionalism in the conduct of foreign policy" across-the-board for fear of decision-makers "beholden to short-term trends in public opinion . . . [and] what we might call the erratic and subjective nature of public reaction to foreign policy questions."
The skeptics, however, have been proven wrong. Time and again, in wars hot and cold, democracy as a system has consistently beaten its competitors -- not despite having decision-makers accountable to their publics, but largely because of it. Openness and democratic control sometimes produce mistakes and embarrassment, but on balance they also produce moderation, success, and -- most important -- legitimacy. These are precisely the qualities that Europe's economic policy needs in the decades ahead. Unless the continent's elites and central bankers can bring themselves to trust their publics more, however, these may be qualities in short supply.