The real threat to central bank independence
Posted on 01-24-2014 07:01
Summary: Everyone likes a good political conspiracy. So when finance ministers start saying they wouldn't mind a weaker dollar, and then central bankers come out with policy statements that point the currency downhill and give it a hard shove, it takes all of about five seconds for someone to yell "political interference!"
Everyone likes a good political conspiracy. So when finance ministers start saying they wouldn't mind a weaker dollar, and then central bankers come out with policy statements that point the currency downhill and give it a hard shove, it takes all of about five seconds for someone to yell "political interference!"
So it was Wednesday, when the Bank of Canada cranked up its warnings over the country's anemic inflation by several notches - sending currency investors scurrying from the Canadian dollar.
Bank of Canada Governor Stephen Poloz, while insisting that his new policy focus had nothing to do with trying to manage the Canadian dollar lower, nevertheless said that a lower dollar would help the country's manufacturing exporters.
This comes just three weeks after federal Finance Minister Jim Flaherty, in a television interview, said that a weaker currency ("somewhere in the 90s") would be good for the country's manufacturing exporters. Mr. Flaherty came under criticism for talking about the currency (and interest rates, too), on the grounds that he was wading into the purview of an independent central bank. He did it anyway.
And so, the conspiracy theorist's alarm bells go off: Mr. Poloz and Mr. Flaherty are in cahoots to engineer a plunge in the dollar, they say. Or, worse, that Mr. Flaherty is stomping all over the central bank's legally entrenched independence and telling Mr. Poloz what to do.
But if you're looking for evidence of political interference, you're almost certainly looking in the wrong place. Finance ministers know better than to directly meddle in the Bank of Canada governor's legal authority to set monetary policy. (Under the Bank of Canada Act, the finance minister can direct the central bank governor to change monetary policy, but it's an extreme measure that must be done in publicly disclosed writing, and would almost certainly trigger the governor's resignation. It's a central bank cyanide pill.)
If there is any conspiracy, it was in Mr. Flaherty conspiring - to the full extent of his authority, and, some would say, possibly beyond it - to decide who gets to set monetary policy in the first place.
Under the Bank of Canada Act, the governor is appointed by the bank's board of directors - but only with the approval of the federal cabinet. Which, effectively, has meant the approval of the finance minister. While historically, the finance minister has merely rubber-stamped the recommendation of the board, our last couple of finance ministers have taken an increasingly active interest in the selection. In the surprise appointment of dark-horse candidate Mr. Poloz last year, Mr. Flaherty took an unprecedented step: He actually interviewed the candidates himself.
It would not be a massive leap of logic to say that the guy conducting the interviews and granting final approval is, for all intents and purposes, the guy choosing the next governor. Some people would say that this infringes on the central bank's independence, and exceeds Mr. Flaherty's bounds under the Bank of Canada Act. Mr. Flaherty wouldn't agree.
Regardless, if Mr. Poloz and Mr. Flaherty seem to be in general agreement on policies that happen to facilitate a weak currency, maybe that's because Mr. Flaherty gravitated toward a candidate for the job who shared his views on a lot of economic matters - including the dollar.
This is certainly less problematic than a direct, specific political interference into the Bank of Canada's policy-setting process. But it's no less insidious.
If you're suspicious of unelected officials controlling powerful policy levers (and there are many people who are), this might actually be a comfort for you. But history has shown that politically motivated monetary policy is notoriously short-sighted and potentially self-destructive. If we are worried about keeping our central bank untainted by politics, we need to start by addressing the back-door influence of the appointment process.