Posted by: Dirk | January 10, 2017

Central bank independence within the government, not of the government!

I’ve been watching one of the “Free to Chose” programs hosted by Milton Friedman, which are very odd to watch in terms of clothing and the absence of any ethnic minorities. What I find interesting about this programme is a sentence by the then former Chairman of the Fed, William McChesney Martin:

When I’ve talked for a long time about the independence of the Federal Reserve, that’s independence within the government not independence of the government.

The way that central bank independence is discussed nowadays seems to imply that central banks are independent from government. A recent article on reads:

Over the past 30 years, most central banks across the advanced economies have been given the ability to conduct monetary policy independently from interference by fiscal and political authorities (Crowe and Meade 2007). Today, almost all central banks in OECD countries are operationally instrument-independent, counting on their own tools to set or target several interest rates, even if none of them is goal-independent, since political bodies give them their mandate.

I reject the notion that it is possible to run central bank “independently from interference by fiscal and political authorities”. An increase in government spending, for instance, increases the amount of reserves in the system when it happens. Perhaps before, the government borrowed from banks, which themselves borrowed from the central bank. This is going on everywhere all of the time, and for me it is plain wrong to say that a central bank can be independent from the Treasury. This is recognized by most modern literature, including the Fed (see this paper).

What Milton Friedman and his insistence on monetary policy did to monetary theory was not advancing monetary thought, but rather a regression to older neoclassical times in which the monetary neutrality was an axiom. Keynes got rid of it, making money explicit, and then Friedman and his followers closed the curtain on Keynes. In the last few years, the picture changed again and Keynes has been revived in a modern form. Fiscal policy made a comeback, and 2017 will see more advancement towards Keynesian positions that stress the role of the state in fighting unemployment that results from leaving it to the market alone to determined the level of jobs available.


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