The Trump administration’s decision to open a criminal investigation against the head of the Federal Reserve (Fed), Jerome Powell, has intensified fears about the independence of the United States central bank, the main body responsible for the economic policy of the world’s largest economy.
The president has criticized the Fed and its chairman for not lowering interest rates quickly enough.
Senior officials at other central banks closed ranks around Powell on Tuesday, saying in a statement that “central bank independence is a cornerstone of price, financial and economic stability, in the interests of the citizens we serve.”
Below is a summary of how independence became a key element in the way central banks around the world manage their economies.
The Fed led the way
The Federal Reserve gained operational independence in 1951, after rising inflation revealed the limits of a monetary policy designed to keep borrowing costs low during World War II.
While the Fed was a pioneer in many ways, it was not until 25 years later that it was able to completely free itself from political interference in setting interest rates.
Former President Richard Nixon’s push to keep borrowing costs low ahead of his 1972 re-election campaign is widely seen, along with rising oil prices, as a contributing factor to the spike in inflation later in the decade.
High inflation-New system
After suffering damage from high inflation in the 1970s and early 1980s, governments around the world sought new ways to manage their economies.
Many of them took the power to decide interest rates away from politicians and put it in the hands of officials charged with keeping inflation low.
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At the end of the 20th century, between 80% and 90% of the world’s central banks had operational independence, according to the Bank of England.
Independence, does it work?
Part of the credit for low inflation for much of the past 30 years goes to other factors, such as the emergence of China and other exporting nations whose low-cost goods helped contain prices.
However, scholars have repeatedly linked the level and volatility of inflation to the degree of independence of central banks in a wide range of countries, cementing its position as a fundamental principle of policymaking in recent decades.
In the United Kingdom, uncertainty about inflation fell by a factor of about four after the Bank of England became independent in 1997, compared with the previous 20 years, the bank’s former chief economist, Andy Haldane, said in a 2020 speech.
Challenges in times of crisis
Broad support for central bank independence came under pressure during the 2007-09 global financial crisis, which was linked to failures by central banks and other regulators charged with overseeing risks in the banking system.
Central banks cut interest rates to near zero and added additional stimulus by buying trillions of dollars in bonds. Then-Fed Chairman Ben Bernanke was compared to a traitor by Republican presidential hopeful Rick Perry, who accused him of printing money for political purposes.
More recently, the British central bank was accused by politicians of fueling inflation with its own quantitative easing program. That pressure intensified when inflation soared to 11% following a surge in energy prices following Russia’s large-scale invasion of Ukraine in early 2022.
Shortly before becoming Prime Minister of the United Kingdom that same year, Liz Truss said she would review the mandate of the Bank of England, something she did not have time for during her brief time in Downing Street. However, the bank’s reputation in the public opinion fell to historic lows, according to surveys by the central bank itself.
While Britain only briefly flirted with a return to political interference, governments in other countries, from Türkiye to India, have sought to exert influence over their central banks. Japan’s prime minister has also historically advocated loose monetary policy.
With information from Reuters
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