The Greatest Myth: Central Bank Independence (Part 1)

When you ask the average Kiwi about why the Reserve Bank is such a good thing I bet you most of them will answer: It is independent.

My question is: Independent from what? Why and why is that a good thing. And are they really independent?

The most common reason given as to why Reserve bank independence is a good thing is that if money creation is in the hands of a government they will inevitably start printing money to appease their electorate.

But it is said no man is an Island and the same goes for the people who run our “independent” Reserve banks. They too are beholden to other people. If they are not beholden to us, the people whom they are sworn to support with wise financial decisions to keep a regular money supply for us to prosper without building bubbles and based on a real world economy then who are those people they are beholden too?


By L. Randall Wray

It has been commonplace to speak of central bank independence—as if it were both a reality and a necessity. Discussions of the Fed invariably refer to legislated independence and often to the famous 1951 Accord that apparently settled the matter. [1] While everyone recognizes the Congressionally-imposed dual mandate, the Fed has substantial discretion in its interpretation of the vague call for high employment and low inflation. For a long time economists presumed those goals to be in conflict but in recent years Chairman Greenspan seemed to have successfully argued that pursuit of low inflation rather automatically supports sustainable growth with maximum feasible employment.


In any event, nothing is more sacrosanct than the supposed independence of the central bank from the treasury, with the economics profession as well as policymakers ready to defend the prohibition of central bank “financing” of budget deficits. As in many developed nations, this prohibition was written into US law from the founding of the Fed in 1913. In practice, the prohibition is easy to evade, as we found during WWII in the US when budget deficits ran up to a quarter of GDP. If a central bank stands ready to buy government bonds in the secondary market to peg an interest rate, then private banks will buy bonds in the new issue market and sell them to the central bank at a virtually guaranteed price. Since central bank purchases of bonds supply the reserves needed by banks to buy bonds, a virtuous circle is created so that the treasury faces no financing constraint. That is what the 1951 Accord was supposedly all about—ending the cheap source of US Treasury finance.

Since the Global Financial Crisis hit in 2007 these matters have come to the fore in both the US and the European Monetary Union. In the US, discussion of “printing money” to finance burgeoning deficits was somewhat muted, in part because the Fed purportedly undertook Quantitative Easing to push banks to lend—not to provide the Treasury with cheap funding. But the impact has been the same as WWII-era finances: very low interest rates on government debt even as a large portion of the debt ended up on the books of the Fed, while bank reserves have grown to historic levels (the Fed also purchased and lent against private debt, adding to excess reserves). While hyperinflationists have been pointing to the fact that the Fed is essentially “printing money” (actually reserves) to finance the budget deficits, most other observers have endorsed the Fed’s notion that QE might allow it to “push on a string” by spurring private banks to lend—which is thought to be desirable and certainly better than “financing” budget deficits to allow government spending to grow the economy. Growth through fiscal austerity is the new motto as the Fed accumulates ever more federal government debt and suspect mortgage-backed securities.

The other case is in the EMU where the European Central Bank had long been presumed to be prohibited from buying debt of the member governments. By design, these governments were supposed to be disciplined by markets, to keep their deficits and debt within Maastricht criteria. Needless to say, things have not turned out quite as planned. The ECB’s balance sheet has blown up just as the Fed’s did—and there is no end in sight in Euroland even as the Fed has begun to taper. It would not be hyperbole to predict that the ECB will end up owning (or at least standing behind) most EMU government debt as it continues to expand its backstop.

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One thought on “The Greatest Myth: Central Bank Independence (Part 1)

  1. I have a big problem with the way our money is created.

    The Banks create money from nothing, then lend it to us and charge us for it! This has to be criminal!
    We desperately need to implement something like what is trying to get going,
    The problem with following this path is that we will have the same problems as Napolean, Abraham Lincoln, Adolf Hitler, and John F Kennedy.
    Napoleon decided France had to break free of the debt and he therefore never trusted this bank. He declared that when a government is dependent on bankers for money, it is the bankers and not the government leaders that are in control. He stated,
    “The hand that gives is above the hand that takes. Money has no motherland, financiers are without patriotism and without decency, their sole object is gain.”

    Lincoln was killed for the printing of the Greenbacks, so was Kennedy. Hitler was attacked, had his nation destroyed by the International Financiers because he also expelled the bankers and began to print his own money.

    I worry, that if we have a true financial revolution in this country, and groups like achieve their goals, I worry about the repercussions from the Bankers. They control the world. In saying that, for our country to be truly free and prosperous, this financial revolution is something that we MUST do.

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