Central Banks and Political Retaliation

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The emergence of many central banks in the world has been linked to the desire of kings to seek additional funding in the face of increased spending on the state apparatus and wars against other countries. The ability of central banks to create cash independently of their precious metal reserves has provided new possibilities for financing expenses The state and its wars without the need for new taxes on its citizens or for debt from large traders and moneymen at home and abroad.

Central banks’ reputation has always been rising and falling. For years, central banks’ prestige has been on the rise. But the correction now seems inevitable, with central-bank independence a major victim. Central banks’ reputation reached its peak before and at the beginning of the century, thanks to the so-called ‘Great Moderation’. Driven by low and stable inflation, sustainable growth, and high employment, central banks were often perceived as masters of the universe, capable of managing the economy – and expected to do so – for everyone’s benefit. The portrayal of US Federal Reserve Chairman Alan Greenspan as ‘Maestro’ is a case in point.

Initially, the 2008 global financial crisis bolstered central banks’ reputations. Thanks to determined action, the monetary authorities made a significant contribution to preventing the recurrence of the Great Depression. Again, central banks were hailed as the global economy’s savior. But central-bank successes fueled very high expectations, encouraging most policymakers to leave macroeconomic management largely to monetary authorities. These excessive burdens of ‘expectations’, and thus ‘operation’, have exposed monetary-policy shortcomings. But central banks cannot simply abandon their new operational burdens, especially with regard to financial stability, which, as the 2008 crisis starkly demonstrated, cannot be sustained only by price stability. On the contrary, an amount of low and stable interest rates could reinforce money fragility, resulting in a ‘Minsk moment’, once plus values collapse suddenly, demolition the complete system. Currently the boundaries of inflation targeting square measure clear, and it's necessary to induce eliminate this strategy.

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Supervision of micro-prudential management, in particular, means the risk of political pressure, interference with central-bank independence, and conflict over policies, all of which can influence financial intermediaries’ behavior, by encouraging them to take greater risks. They know that their supervisors have powerful tools at their disposal – for example, they can reduce borrowing costs, thereby protecting banks (at least for a while) – and a strong interest in protecting their reputations. But, given central banks’ overburden, their reputations may be even greater than they can.

While this is a global phenomenon, the ECB is particularly overburdened. As the central bank of the 19 member states of the European Monetary Union, the ECB also faces ‘institutional overburden’. This became clear in May 2010, when the ECB took charge of buying state government bonds that would otherwise have seen large increases in long-term interest rates. This intervention was a certain loss for the ECB. His motives were essentially political: the ECB was doing the work of policymakers who were unwilling to honor their commitments. But if the ECB refused to intervene, financial markets would have faced major disruptions, and the ECB would have been held responsible, rightly or falsely.

From that point on, however, the ECB has taken on the political role of ensuring not only the euro’s survival. It is also the continued inclusion of every member state in the European Monetary Union. This attitude led many to accuse the European Central Bank of exceeding its authorization and violating the European treaties. But the European Court of Justice and the German Constitutional Court have rejected this view altogether. Yet more litigation about the ECB’s unconventional monetary-policy measures is underway. Against this background, it may be unsurprising that central-bank independence is being discussed again – de jure or de facto. Central banks’ independence has always been intended to enable monetary policy to focus on maintaining price stability, without coming under political pressure. While this approach has always been controversial, given its implication of handing over much control of the economy to unelected technocrats, past bouts of inflation have reinforced widespread acceptance of central-bank independence. But when central banks’ mandate exceeds price stability, its independence may seem increasingly irrelevant in a democratic society. This is particularly true of the ECB: the stronger the perceived link between extending the ECB’s mandate and politics, the more critical it is to be an independent entity.

Elected politicians’ failure to act properly – especially in some eurozone countries – has turned central banks into the ‘only game in town’. This has proved to be less of a threat to its prestige than to its independence. The ECB, in particular, is facing an increasingly powerful attack on its status as an independent institution, regardless of whether it can ‘bailout’ the European Monetary Union. After all, it must be very strong to succeed – stronger than at any level that a democracy accepts.

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Central Banks and Political Retaliation. (2022, August 25). Edubirdie. Retrieved April 17, 2024, from https://edubirdie.com/examples/central-banks-and-political-retaliation/
“Central Banks and Political Retaliation.” Edubirdie, 25 Aug. 2022, edubirdie.com/examples/central-banks-and-political-retaliation/
Central Banks and Political Retaliation. [online]. Available at: <https://edubirdie.com/examples/central-banks-and-political-retaliation/> [Accessed 17 Apr. 2024].
Central Banks and Political Retaliation [Internet]. Edubirdie. 2022 Aug 25 [cited 2024 Apr 17]. Available from: https://edubirdie.com/examples/central-banks-and-political-retaliation/
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