Central banks are under more political scrutiny now than at any time in the past half century. Many observers worry that their independence—which is vital if monetary policy decisions are to be made with sufficient attention to the long term and central banks are to be able to restore and maintain price stability—could be a casualty of the growing political dissatisfaction with the scale and persistence of inflation.
Hiring Bernanke may help head off potentially damaging interference from short-termist politicians
The recent appointment of Ben Bernanke, who served as the chair of the Board of Governors of the Federal Reserve from 2006 to 2014, to review the Bank of England's forecasting "and related processes" can be interpreted as an attempt by the bank to head off potentially damaging interference from politicians. The review was precipitated by the Bank of England's disappointing record in bringing inflation under control, though the bank was also in the public eye during a very controversial episode in late 2022, when the yield on British government bonds soared in the days following the announcement of the government's budget, an event that led to the resignation of the prime minister and the chancellor of the exchequer.
The concept of an external review is not new for central banks. The International Monetary Fund (IMF) and the World Bank have been conducting detailed reviews under the Financial Sector Assessment Program (FSAP) since 1999. For the most systemically important countries, these FSAP reviews are updated every five years or so. In addition to assessing the risk of the various components of the financial system, the reviews conduct a detailed examination of laws and administrative practice.
Each FSAP review is carried out by a large team—sometimes numbering two dozen people or more—usually drawn mainly from IMF and World Bank staff but also including other experts, such as current or former central bankers from other countries. The FSAP teams come armed with highly detailed assessment templates, and their lengthy reports and recommendations are published. The reviews can be pointed. In 2020, for example, the FSAP for the United States called out the soft-pedaling of resolution planning for medium-sized banks (such as Silicon Valley Bank).
A growing number of central banks have also been the subject of periodic or ad hocindependent reviews commissioned by legislatures or governments. National central bank laws are beginning to provide explicitly for such reviews as part of the formal governance structures of central banks. Typically conducted by two or three retired senior officials of other central banks or academics, such reviews tend to be lighter in resources than the FSAPs (though the recent review of Australia was supported by a secretariat team that included more than a dozen people). Independent reviews tend to zoom in on top-level decision making and governance.
A classic external review is the 2016 report on the Swedish Riksbank, conducted by former Bank of England governor Mervyn King and the late US academic Marvin Goodfriend, which documented the deliberations of an especially disputatious Riksbank Executive Board in 2010-15. Whether in response to that report or not, a more collegial atmosphere was in evidence in subsequent years. If sufficiently penetrating and candid, these reports can have consequences. The 2023 external review of the Reserve Bank of Australia is viewed as having led to a wide-ranging restructuring of that institution. Shortly after the report appeared, in April, the government appointed Michele Bullock to succeed Philip Lowe, an extension of whose term as governor had previously been thought likely.
Although Bernanke's task for the Bank of England is essentially a technical one, it is not just about the mechanics of arriving at accurate point forecasts; it extends to the use of forecasts and their role in policymaking. The bank's willingness to submit all of these areas to scrutiny by such an eminent and independent scholar may be a way of partially disarming some of its critics—even if some cynics dismiss expertise as irrelevant.
The Bank of England has been a leader in accepting independent evaluation of its work
In a 2014 innovation that other institutions, including the Federal Reserve, could do well to follow, the Bank of England was the first central bank to follow the IMF's lead by establishing an internal but independent evaluation office (it will assist Bernanke in his review). Others, including the Federal Reserve, would do well to follow suit.
A previous wave of external reviews, in 2013-14, looked into the transparency of decision making, liquidity provision, and—yes—forecasting. In response, the bank changed its mode of operation, informed by the recommendations of the subject matter experts who carried out the reviews rather than by populist political pressure. In advanced-market economies, more use of public external reviews by independent subject matter experts might prove a useful middle course between leaving central banks to work in splendid isolation and subordinating them to the finance minister. (Full disclosure: I was involved in such reviews for Sweden, South Africa, and Iceland.) If sufficiently robust, such reviews might be enough to slake the thirst of politicians eager to take more control of central banking.
Emerging-market central banks are less independent
In contrast, in emerging-market economies they are not likely to be enough to safeguard the limited degree of independence that most central banks have been able to carve out for themselves. The fact that incoming People's Bank of China (PBOC) governor Pan Gongsheng (succeeding the widely praised Yi Gang) is also the Communist Party secretary for the PBOC might, at least at first sight, be interpreted as strengthening political influence over the PBOC, which has never been strongly independent. (The PBOC may also be becoming less influential in China's decision-making structures, considering other institutional changes that have recently been made in China's financial regulatory architecture as well as the fact that the new governor has not been appointed to the Party's Central Committee. Correctly interpreting the delicate power balance between party and governmental institution in China is not always easy for outsiders.)
Not all unscheduled leadership changes are attacks on central bank independence. One of the first acts of incoming Nigerian president Bola Tinubu was to suspend Godwin Emefiele as governor of the Central Bank of Nigeria in June. Coincidentally, on the same day, Turkish president Recep Tayyip Erdoğan brought over a US-based investment banker, Hafize Gaye Erkan, to serve as governor of Turkey's central bank, signaling an end to an idiosyncratic period there. In both cases, the departing heads had been far from independent and had pursued unwise, politically dictated, policies. Their successors have made what market observers regard as promising starts, returning to more orthodox policies, though clearly their tenure still depends on presidential edict.1
A century ago, long-time Bank of England governor Montagu Norman used to brush aside criticism with the aphorism "the dogs bark, but the caravan moves on." Today's central bankers must submit to much more intrusive scrutiny if their independence is to be maintained.
This publication does not include a replication package.