Bank of Japan and Central Bank Independence

The Bank of Japan is the fourth G10 central bank that meets this week.  The Bank of England and the European Central Bank did nothing as expected.  The Reserve Bank of Australia did not just deliver a 25 bp as indicative prices in the derivatives market had favored, even if many economists were taken by surprise, but it kept the door open to additional rate cuts.  Subsequent economic data, including the unexpected widening of the current account deficit and weak retail sales pushed the door further.  

The BOJ is likely to follow the BOE and ECB and no nothing rather than the RBA.  A compelling case can be made for additional easing.  The BOJ has still not broken deflation's grip.  The economy has weakened considerable as global head winds hurt exports.  The Tankan survey showed a deterioration in sentiment.  Yet, after expanding its asset purchase program a couple of weeks ago, any fresh measures now would imply it was not aggressive enough then.

The meeting would hardly be noteworthy, except that Economic Minister Maehara will be attending.  Can one imagine Treasury Secretary Geithner attending an FOMC meeting; or, Germany's Roesler or the EU Commissioner Ollie Rehn sitting in on an ECB meeting ?  

Conventional wisdom argues that central banks need to be independent from politicians, who are assumed to be motivated by short-term political interests.  We have opened two lines of questioning about this seemingly universal belief.  

First, we have suggested that this may be a thing of the past. As policy makers respond to the crisis at the end of a credit cycle, it is important that monetary and fiscal policy work together.   Loose monetary policy is Europe and the US may be warranted in the face of the contractionary impulses emanating from fiscal policy.  

Some of you may be scratching your heads.  What contractionary impulse from the US?  Under appreciated is the fact that the government sector en toto continues to be a net drag on GDP.  That is because, simply if not crudely put, Washington has not spent money in sufficient size to offset the cut back on the state and local level.  Another way of saying this is that the private sector is doing better than the economy as a whole.    

In any event, if the analysis is correct and in this crisis, monetary and fiscal policy need to be coordinated, we go on to ask whether this is desirable.  

Often it seems that central bank independence has become a ideological slogan rather than some kind of best practices.  It denigrates politicians in themselves and who they represent.  The politicians who we should not trust with monetary decisions, seem sufficiently competent to be entrusted with critically important issues such as national security and domestic peace.  

Like other bureaucracies and power centers, central banks resist checks and balances. Yet this is a basic and fundamental principle of modern representative government.  What makes monetary policy so special that it needs to be isolated from democratic accountability?  The fear is that democratic forces would seek easy money to the detriment of the creditors.  

Yet if that argument is treated as a hypothesis rather than dogma, it can be tested.  The BOJ is an interesting place to test the hypothesis.  The BOJ has among the major central banks arguably the least amount of independence as Maehara's decision indicates.  However, the BOJ has delivered price stability like no one else.  

True price stability cannot mean be 2% inflation a year.  The BOJ has delivered closer to zero inflation than any other central bank.  That is its annual inflation rate has deviated from zero less than other central banks.  It is true that CPI is slightly negative, but only slightly.  So here we have a "dependent" central bank that has in fact delivered price stability.  

One can find examples of "dependent" central banks experiencing higher inflation and one can find independent central banks that have also overshot their targets as often, if not more so, than achieving them.  

Maehara's presence at the BOJ meeting does not change expectations for the outcome.  It is interesting to note, though that Maehara has reportedly indicated the intention to sit in on as many BOJ meetings as possible.  Maehara also according to reports is sympathetic to BOJ purchasing foreign bonds not for intervention purposes but for monetary purposes. 

The fact that Maehara may not be in office very long, if elections are called as anticipated, should provide little succor to the BOJ's independence. The LDP, which is likely to replace the DPJ, seems even more intent on encroaching into the central bank.  

The old saying about how if a camel's nose goes into the tent, the body soon follows comes to mind.   Maehara's attendance could simply be a camel's nose.