Political pressure on central banks is rising worldwide, and independence is at risk
Moves by presidents and populist parties are testing central-bank independence from Washington to Jakarta. Markets remain calm, but higher inflation could make politics decisive.
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By Torontoer Staff
Central-bank independence is under renewed assault from politicians in the United States, Japan, Britain, the euro zone and several emerging markets. The most immediate flashpoint is the Justice Department’s recent subpoenas to the Federal Reserve, announced by Fed chair Jerome Powell on January 11, after months of pressure from President Donald Trump to cut interest rates faster.
Those developments expose a broader trend. The post‑war settlement that insulated monetary policy from short-term politics has come under strain as governments carry large debts and face populist challenges that promise relief through cheaper borrowing.
Why independence mattered
Central-bank independence became a mainstream policy idea after the second world war. The 1951 agreement between the U.S. Treasury and the Federal Reserve ended direct pressure on the Fed to finance government borrowing. West Germany’s Bundesbank then established a model of price stability that influenced other countries in the 1970s and 1980s. Academic research that followed strengthened the case for delegation, arguing that elected officials have incentives to pursue looser monetary policy for short-term gains, at the cost of higher inflation.
The result was a long decline in inflation and a period of lower macroeconomic volatility. Emerging markets also benefited, narrowing the inflation gap with advanced economies as independent institutions and inflation-targeting frameworks spread.
Where politicians are pressing
Pressure takes different forms in different countries. In the United States the White House has publicly pressured the Fed to loosen policy, and the department of justice’s subpoenas to the Fed chair mark an extraordinary escalation. That has exposed Fed officials to the risk of personal legal entanglements and politicised confirmation fights over leadership appointments.
the Department of Justice had served the central bank with subpoenas
Jerome Powell
In Japan, prime minister Takaichi Sanae campaigned against higher interest rates. The Bank of Japan is formally independent, but the government’s view has repeatedly reshaped policy, most notably under Shinzo Abe when authorities and the central bank jointly pushed unconventional stimulus to defeat deflation. Rising inflation and a 30-year high in rates now put fiscal and monetary policy on a collision course, because Japan’s net debt exceeds 130 percent of GDP.
In Britain, parties on both the populist right and left have criticised the Bank of England’s balance-sheet and suggested removing interest on the reserves banks hold at the central bank. That proposal would reduce banks’ income, effectively transferring resources to the government and undermining the central bank’s operational independence.
The euro zone faces a different strain. The European Central Bank’s independence is enshrined in treaty, but the larger fiscal needs of member states and renewed defence and ageing-society spending increase the temptation for fiscal pressure. France, with debt above 115 percent of GDP and a large deficit, is singled out as a likely source of friction.
We won't be able to avoid a discussion with the [ECB] about French debt
Jordan Bardella, National Rally politician
In emerging markets the backsliding has often been more direct. Indonesia has agreed to increase the interest it pays on government deposits and has been buying domestic bonds again. Central bankers in countries such as Ghana, Turkey and Nigeria have faced legal or political reprisals in recent years.
Markets and the politics of inflation
Markets have, so far, reacted with surprising calm. Ten-year U.S. Treasury yields have not shifted dramatically since the Powell subpoenas became public. That reflects a combination of factors: Powell’s public defence of Fed independence, some Republican senators signalling they will block nominations until the matter is resolved, and the political cost to incumbents of rising inflation.
Inflation is politically explosive. Voters punish governments for higher prices, which limits the appetite of many politicians to openly embrace looser monetary policy. That constraint offers some protection for central banks, but relying on political restraint is hazardous. If governments succeed in eroding institutional safeguards, the result could be higher inflation and weaker economic credibility over time.
What to watch next
- Outcome of the Justice Department’s subpoenas to the Fed, and any related legal actions.
- Who President Trump nominates to succeed Jerome Powell when his term ends in May, and how the Senate responds.
- The U.S. Supreme Court hearing on January 21 regarding the potential removal of Fed governor Lisa Cook.
- Fiscal plans and political developments in France and Italy that could force the ECB into awkward trade-offs.
- Actions by Indonesia and other emerging markets that may set precedents for central-bank financing of governments.
Central banks helped to lower inflation and stabilise economies for decades by operating with a degree of autonomy from short-term politics. The current wave of politicisation threatens that achievement. Preserving credible, rules-based monetary policy will require stronger institutional norms and, in democracies, public support for those norms. Absent that, monetary policy risks becoming a casualty of fiscal pressure and political expediency.
central-bankFederal Reserveinflationmonetary-policypoliticsECBJapan
