Central bank independence

From Wikipedia on Central Bank Independence:

"Advocates of central bank independence argue that a central bank which is too susceptible to political direction or pressure may encourage economic cycles ("boom and bust"), as politicians may be tempted to boost economic activity in advance of an election, to the detriment of the long-term health of the economy and the country. In this context, independence is usually defined as the central bank’s operational and management independence from the government."

"In addition, it is argued that an independent central bank can run a more credible monetary policy, making market expectations more responsive to signals from the central bank. Recently, both the Bank of England (1997) and the European Central Bank have been made independent and follow a set of published inflation targets so that markets know what to expect. Even the People's Bank of China has been accorded great latitude due to the difficulty of problems it faces, though in the People's Republic of China the official role of the bank remains that of a national bank rather than a central bank, underlined by the official refusal to "unpeg" the yuan or to revalue it "under pressure". PBoC independence can thus be read more as independence from the US which rules the financial markets, not from the Communist Party of China which rules the country. The fact that the CPoC is not elected also relieves the pressure to please people, increasing its independence."

"Governments generally have some degree of influence over even 'independent' central banks; the aim of independence is primarily to prevent short-term interference. For example, the chairman of the U.S. Federal Reserve Bank is appointed by the President of the U.S., and his choice must be confirmed by the Congress."

"The powers of such appointed positions are usually highly limited. The main decisions on monetary policy, to name but one example, are made by privately appointed figures independently of any elected political powers. Such is the case with the Monetary Policy Committee of the Bank of England, where the majority power is elected by and given to members of private corporations."

"International organizations such as the World Bank, the BIS and the IMF are strong supporters of central bank independence. This results, in part, from a belief in the intrinsic merits of increased independence. The support for independence from the international organizations also derives partly from the connection between increased independence for the central bank and increased transparency in the policy-making process. The IMF’s FSAP review self-assessment, for example, includes a number of questions about central bank independence in the transparency section. An independent central bank will score higher in the review than one that is not independent."

The most famous case of political interference in central bank monetary policy is probably Nixon's 1972 re-election bid which you can read about in this short essay and this article as well. Here are the key parts of the classic story of how Nixon manipulated the American central bank:

"The classic case of the Fed subordinating good policy to politics was in 1972. Richard Nixon was acutely aware that Fed tightening in late 1959 brought on a recession that began in April 1960. As the nominee of the incumbent party, Nixon took the blame for slow growth. In his book Six Crises, he complained bitterly that the Fed had, in effect, thrown the election to John F. Kennedy, whose most potent campaign pledge was that he would get the economy moving again."

"When Nixon became president in 1968, he vowed that he would not let the Fed do it to him again. At his earliest opportunity, he appointed a trusted aide, Arthur Burns, to the chairmanship of the Federal Reserve. His job was to make sure that money and credit stayed easy through the 1972 election."

"However, Nixon did not want to take any chances. He ordered White House staffers to keep an eye on Burns and push him to err on the side of monetary ease...The problem was inflation. It jumped to 6.2 percent in 1969 after having been in the 1 to 2 percent range for many years. In essence, the inflation rate had tripled in a very short period of time. The recession, which began in December 1969 and ended in November 1970, brought it down only very little — to 5.6 percent in 1970."

"Under normal circumstances, the Fed would have tightened monetary policy to bring down inflation. But Nixon wanted to keep monetary policy loose in order to make sure the economy was robust going into the election. This led to the imposition of wage and price controls in August 1971. While everyone knew they would not work for long, the controls reduced inflation enough to keep monetary policy expansive through November 1972, which was all that mattered...The policy helped reelect the president but also assured the next cycle of boom and bust...Once past the election, the price controls began to break down. Inflation jumped to 8.7 percent in 1973 and 12.3 percent in 1974. Another recession began in November 1973 and didn’t end until March 1975."