It is amazing how quickly conventional wisdom can shift. Just a few years ago, most people would have considered as heretical a proposal that central banks should make decisions independent of the influence of the executive and legislative branches of government. Today, central bank independence is universally seen as key to macroeconomic stability and is a litmus test of political maturity.
There are several reasons why opinions shifted toward favoring the independence of central banks. First, many central banks pursued monetary policies that caused inflation or delivered cycles of illusory booms that gave way to destructive busts.
We learned that the impact of monetary and credit policy is so pervasive that political influences should be minimized. This same reasoning is reflected in the movement toward market-based economies seen in the wave of privatization and the transition from socialism and communism. Citizens and policy makers have discovered the community benefits from depoliticizing economic and social life. Those who suffered under Mao’s Cultural Revolution or were brutalized by apartheid or genocidal policies understand the dangers of allowing politics to determine life outcomes.
Whenever political decisions are made about allocating resources, there is always an element of coercion because governments have a monopoly over the legal use of violence. While many people feel obliged to pay taxes, it is hard to describe the process as a purely voluntary exchange.
In place of politic decisions, markets provide the other principle alternative for deciding economic outcomes. Market solutions are unavoidably imperfect since they are nothing more or less than the joint decisions made by a group of individuals who reveal their values through purchases and sales. Exchange that takes place in markets is entirely voluntary.
Another area where that would benefit from greater depoliticization involves the formulation of fiscal policy. Policy makers have some basic options. They can alter economic conditions through fiscal policies that impact upon government budgets (spending and taxes) or by using monetary policy to change interest rates and the availability of credit. Or of course, they could pursue some combination of monetary and fiscal policy.
With fiscal and monetary policies under the control of politicians, there is a temptation to misuse them. Politicians up for re-election often give into the temptation to implement policies to provide an impression of greater economic prosperity. Unfortunately, the impacts of both fiscal and monetary changes suffer from long and variable lags. When the election is over, the short-run gains in political support for incumbents give way to long-term costs in the form of macroeconomic instability.
Therefore, ideally we should set up an independent agency to decide upon appropriate fiscal policies that would be directed toward achieving a stable path for long-term growth. Other objectives would be to target long-term debt to minimize the burden on the economy and upon future generations.
It would be empowered to alter tax and spending policies in response to cyclical conditions while taking into account structural goals. Such an agency would be able to implement budgetary changes that are often tied up in parliamentary committees or held hostage to partisan interests.
For example, a decline in economic activity might be offset by forcing interest rates down or by cutting taxes. Changes in interest rates can be done very quickly by the central bank, but it will take 12-18 months to have their full impact. Tax cuts can have an almost immediate impact on household and business spending, but it often takes a long time for policies to clear the legislative process and gain executive approval. An independent agency that sets and steers fiscal policy would minimize delays in decision making.
Another problem of politicizing fiscal policy relates to the opportunities for corruption. For example, Japan’s ruling Liberal Democratic Party directed vast sums of discretionary spending to infrastructure projects because of the support given them by corporations in the building trade. The U.S. Congress is famous for its “pork barrel” spending on special interests. Such abuses become worse where it is more difficult for citizens to hold their leaders accountable. These and numerous other examples indicate that it is high time to take politics out of policy making.
While this proposal may seem radical, it is only a matter of time before it will be debated. Countries that seek to improve their chances to having robust and sustainable growth will move quickly to establish independent agencies that remove politics from decisions about their fiscal policies and priorities.
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