Stability, Democracy and Central Banks
Dec 7, 2010

Stability, Democracy and Central Banks

Democracy is a great thing but it is not a perfect thing, and there are parts of our society which are, and should be, somewhat outside of our democracy. In particular, democracy is often not stable in the short term with considerable ebbs and flows of political opinion. Since perhaps the most important aspect of central banks is ensuring economic stability, is is natural that these be separated at arms length from the democratic process. However, they must not be removed entirely and it is the right balance between stability and democracy that we must strive for.

A principle role of central banks is ensuring stability in our societies economies. Through manipulation of interest rates in the reserve system, as well as various other more extreme monetary policies such as quantitative easing seen used during the recession, the central banks control acutely the level of liquidity in money markets and hence influence much of the economy. They have several stated objectives such as growth, but ensuring stability is perhaps the most important.

To ensure stability requires taking these economic policies outside of short term political considerations. Politicians like to advocate for seemingly extreme and ideological positions, especially during election seasons, and if the economic policies of central banks are subject to these fluxing political opinions they simply won't be acting in the best interest of maintaining stability. As the role and scope of government is an often debated political issue, the whims in this debate can influence economic policy to the loss of stability.

Monetary policy is a highly technocratic issue that is often hard to understand and to convey to a population who cannot be relied on to adjudicate optimal economic policy that maintains stability. Populations in a democracy should be and are the only ones who can determine the balance of values in our society. They might determine the relative merits of a value such as egalitarianism compared to freedom or even compared to economic growth. Questioning the capacity of the people to be adjudicators of monetary policy is not being dismissive of democracy, it is acknowledging where the strengths in a democratic society are and where are the weaknesses.

We thus conclude the importance of central banks who exist at arms length from a societies democratic institutions. However, we must be careful to prevent these institutions from being too far removed from the democratic process. The danger is that the objectives or implementations of central banks, stability being merely one of them, may be at odds with the values prescribed by the people through democracy.

Perhaps the easiest thing to see is the need to have central banks face very clearly the tests of transparency and accountability needed in democratic institutions. Central banks must ultimately be accountable to the people even if they remain at arms length from democratic processes and transparency is a key component of maintaining acceptability. Many of the concerns regarding the Fed focus on the issues that it is not at all transparent and accountable and indeed may be acting in the beat interest of a select few financial elite oppose to the people.

More than just being accountable, one must keep the goals of central banks in line with the values of the people prescribed through democracy. We can usually all agree that stability is important. However, we may also find that equality is an important value and the actions of central banks should be made to promote equality in addition to stability.

There is a fairly reasonable theoretical test for how much democratic processes should and should not encroach on central banks. Namely, where stability is not affected by the ebbs and flows of short term politics, democratic processes should be prevalent. Conversely, when stability may be affected by short term politics, the institutions should exist at some distance. Being transparent, for instance, is if anything going to increase stability and not decrease it and so absolutely central bankings being transparent should face the full tests of democratic processes.

We face a lot of criticism about central banks in our society - I have done so myself - and much of it is justified, but the point of this post was to remind ourselves that there are valid reasons for the arms length existence of central banks from democracy. I fear this length has gotten somewhat too long, that it has become too far removed from democracy, but that it ought to be somewhat removed remains true.

Thoughts on this post? Comment below!

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