Crisis threatens to curb central banks

By Jon Hilsenrath, Brian Blackstone, and Jaeyeon Woo
The Wall Street Journal
Monday, January 11, 2010

http://online.wsj.com/article/SB1000142405274870358570457465044136754428...

Politicians are taking bolder actions to influence monetary policy, signaling that the global financial crisis may end up reining in the independence of many central banks.

In the past week, a policy standoff prompted Argentina's president to fire the country's central-bank chief -- who was reinstated the next day by a court order. In South Korea, the government sent a political official to a central-bank policy meeting for the first time in a decade. Officials at central banks including the Federal Reserve say they worry that similar political challenges are heading their way.

Independence is vital for effective central-bank operations, economists, and central bankers say. Many decisions, such as raising interest rates to fight inflation, are politically unpopular but considered necessary to effectively manage the economy. Many banks have only recently won independence, notably the Bank of England, in 1997, and the Bank of Japan the following year.

That independence is now under threat and is figuring in talks among central bankers gathered in Basel, Switzerland, this week for annual meetings at the Bank for International Settlements. Central banks are vulnerable to political meddling because they became deeply involved in government-led efforts to rescue the global economy.

Central banks also took extraordinary measures on their own. The Federal Reserve bought mortgage-backed securities and took complex derivatives as collateral for loans. The Bank of England essentially printed money when it bought swaths of government bonds. The European Central Bank, the Bank of Japan and others took similar steps.

For now, actual infringements on independence remain rhetorical or isolated among smaller countries. Argentina defaulted on its international debt in 2001, complicating the government's relations with the central bank even before the financial crisis. And recent political moves in South Korea mirror similar policies already in place at the ECB, the Bank of England, and the Reserve Bank of India, among others.

In the U.S., Congress has reacted to a tide of populist anger by calling for greater scrutiny of the Fed's actions. A bill with broad support among lawmakers would subject the Fed to more comprehensive Congressional audits and permit lawmakers to delve deeper into Fed decision-making. A Senate proposal would give lawmakers and the White House more say in the governance of the 12 regional banks scattered around the country. Meanwhile, the Obama administration, with the Fed's support, has proposed limiting the central bank's ability to undertake last-minute rescues of banks without White House approval.

The Fed is more vulnerable to political interference because it has waded more deeply than ever into the U.S. economy. It is purchasing more than $1.7 trillion in Treasury and mortgage debt and partnered with the government to rescue companies such as American International Group Inc. and Citigroup Inc.

"The fact that central banks have done a lot in the crisis and not everybody agrees with everything they did, that is an issue," says Ted Truman, a former Fed staffer who is now a researcher at the Peterson Institute in Washington.

Given the concerns at the Fed, other big central banks are also worried. The ECB's multinational structure perhaps makes it less vulnerable to political interference than the Fed -- but that hasn't stopped governments from trying. Last week, President Nicolas Sarkozy repeated a chronic French complaint that the euro is too strong, which could be seen as calling indirectly on the ECB to refrain from raising rates. ECB officials didn't comment in response.

The Bank of England and the Bank of Japan face new political challenges due to elections.

The Bank of Japan became independent in 1998 -- a development barely recognized by the longtime ruling Liberal Democratic Party. The newly elected Democratic Party of Japan, by contrast, defended BOJ independence before its landslide victory -- but changed its rhetoric after coming to power.

In November, Banking Minister Shizuka Kamei said: "The Bank of Japan is asleep at the wheel as usual." In the same month, Naoto Kan, then head of a newly created budget bureau, said: "We need comprehensive measures to address the current economic situation. I hope the BOJ will take steps in a way that will answer our hopes." Last week, Mr. Kan was named finance minister. In a news conference the day after his appointment, he again appeared to be dictating policy to the central bank, saying: "With help from monetary-policy steps, I'd like to avoid the economy from falling into a double-dip recession."

In the U.K., an election is required by June, freighting the BOE's actions with political challenges. That is even more the case because the BOE has spent hundreds of billions of pounds buying bonds that the government issues, essentially printing money to boost the economy. Figuring out how to exit such a policy amid an election campaign will be a huge test of the BOE's fairly recently won independence.

One country has little concern about the issue of central bank independence: China. The Chinese central bank is a government department in charge of the nation's monetary policy. The issue of political "interference" never arises in Beijing because there is no independence to compromise.

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