1. Do independent central banks
compromise representative democracy?
Patrick SIMION
The first central banks were created in the seventeenth century (bank of England in 1694 and
bank of Sweden in 1664) to help monarchs have loans to pay for war. However most central
banks were created in the late 19th century or beginning of the 20th century during the gold
standard period. The US Federal Reserve for example was created in 1923. These central banks
now mainly issue banknotes, provide liquidity to banks against collateral and act as ‘lenders of
last resort’ to banks but they are not meant to finance governments any more. In other words they
control the quantity of base money and the price of liquidity. David Hume showed in Of Money
in 1752 that the quantity of money is neutral on the long-run. However the Big Depression
highlighted the devastating social effects of high inflation and there is now a consensus that
monetary policy should target low inflation. It is however not clear which institution is best to
carry out monetary policy and it appears democratic ideology might be in contradiction with the
economic ideas.
In his book “central banking in theory and in practice” (1998), Blinder defines an independent
central bank as “a central bank [that] has the freedom to decide how to pursue its goals and […
whose] decisions are very hard for any other branch of government to reverse”.
Democracy is often summarized as being a regime in which the power is help for the people and
by the people. Representative democracy is a variety of democracy in which policymaking is

2. delegated by the people to elected representatives.
Independence means central bankers have a wide discretion in conducting monetary policy
without being directly accountable to the population since they are not elected. According to
some critics such as the journalist Phillip Inman (2012), “More policy decisions should be left in
the hands of the chancellor [of the exchequer], rather than unelected officials at the Bank of
England. Mervyn King's successor will be appointed to an unduly powerful role for an
unprecedented eight-year term”. The increasing central bank independence during the last twenty
years has raised concerns that delegating so much power to unelected officials might be
dangerous and in contradiction with the basic principles of representative democracy. To try to
understand if independent central banks compromise representative democracy, we shall first
explain why monetary policy must be independently conducted. We shall then look at the
different forms of independence and the checks and balances in Europe, the United Kingdom and
the United States. Finally we shall see that transparency and coordination between central banks
and governments seems the ideal solution to the trade-off between economic efficiency and
democratic accountability.
***
Most academics have come to the consensus that monetary policy should seek to achieve low
and predictable inflation. Even though this goal might not reflect individual preferences, it is
socially as well as economically optimal and requires governments to delegate monetary powers.
Representative democracy is based on the idea that governments should be elected by the people

3. and are accountable to the people. The details might differ according to the electoral system but
representative democracy broadly leads to implementing the policy preferred by a majority. This
seems reasonable regarding social issues or foreign policy but for economics issues, the
majority’s preference might be unsustainable. This is for example the case of common good
provision: individuals each want to use the common resource as much as possible which leads to
a sub optimal equilibrium. It seems that in terms of monetary policy, individuals’ preferences
also differ from the optimum equilibrium. Individuals differ in their exposure to the
distributional consequences of inflation and unemployment. Retired people usually have more
capital and want very low inflation not matter what the unemployment rate is while young
workers with mortgages individually favour inflation and employment. Generally speaking right
wing parties have been more inflation averse than left wing parties who are attracted by the
redistribution effects of inflation. Economists have nevertheless shown that low inflation and
time consistency are requirements for an efficient monetary policy. Even among the public, high
inflation became very unpopular in the 1970s because it came with high volatility which made
outcome unpredictable.
During most of the 20th century, central bank policy was conducted by governments. In 1983,
Barro and Gordon showed that many past mistakes in monetary policy come from the fact that
governments try to use the short term trade-off between unemployment and inflation, losing their
credibility and creating an inflationary bias. Clarida, Gali and Gertler (1999) summarize the
results of non-independent monetary policy: “If the central bank desires to push output above
potential then under discretion a suboptimal equilibrium may emerge with inflation persistently
above target, and no gain in output.” The gains from independence and commitment occur no
matter what the primarily objective is: “If price-setting depends on expectations of future

4. economic conditions, then a central bank that can credibly commit to a rule faces an improved
short-run trade-off between inflation and output. This gain from commitment arises even if the
central bank does not prefer to have output above potential. The solution under commitment in
this case perfectly resembles the solution that would obtain for a central bank with discretion that
assigned to inflation a higher cost than the true social cost.” Again we see the oxymora of a
democratic central banker: a representative official cannot give a higher relative cost to inflation
than society as a whole. Moreover, election outcome is often difficult to predict and in many
countries voters have an increased preference for changing governments which is incompatible
with a long term commitment required for efficient monetary policy making. According to Alan
Blinder, “the central bank must have the freedom to do the politically unpopular thing.”
In order to solve this time inconsistency problem, governments in most countries have gradually
ceded the monetary policy powers, granting the central banks independence.
*
To overcome the credibility problem, a central bank must establish a good reputation. It can
extend its time horizon so that a repeated game with private participants can be established. This
can be done through long mandates for governors of central banks. Rogoff also suggested in
1985 selecting conservative central bankers that are more averse to inflation than the average
population. Walsh, Persson and Tabellini (1995) introduced the idea that central bankers should
have incentive-compatible contracts such as inflation target related pay. All these are opposed to
democratic representation. However, central banks were created without breaking any
democratic rule, are accountable in several ways and have variable independence.

5. Central banks are independent in that in most countries they do not accept instructions from the
executive branch (except in some cases on exchange-rate policy). Literature usually distinguishes
three levels: independence in goals, targets and instruments or implementation.
No central bank has independent responsibility to define its goals. This is regarded as being
reserved to the executive branch but is in fact protected by law (UK1
, US2
, Japan3
) or by
constitutional dispositions (Eurozone4
) and therefore difficult to change. These four previous
examples require price stability, no exchange-rate stability, output stability (on an equal footing
for the US and secondary for the UK) and financial stability (except for the ECB originally).
Some central banks such as the Fed and the ECB have independent target but the Bank of
England’s target is fixed by the Chancellor of the Exchequer.
The real independence relies in the instruments. These can be briefly summarized with the four
transmission channels defined by Benoit Coeure: interest-rate channel (traditional Keynesian link
between the interest rate, savings and investment. Federal Funds Target Rate; ECB main
refinancing rate: Bank of England Bank rate), credit channel or liquidity channel (importance of
private banks balance sheet), exchange rate and asset price channel.
These different levels highlight that independence is thoroughly enshrined to protect central
banks but also limited to instruments and sometimes targets. Moreover the main democratic
check is central banks’ accountability to elected representatives (legislative or executive branch).
This accountability takes many different forms across countries. The ECB is required to publish
an Annual Report for the European Parliament, the European Commission and the EU Council.
The Federal Reserve has to present to the Congress’ banking committees twice a year on its
1 Bank of England Act
2 Balanced Growth and Full Employment Act (Humphrey-Hawkins Act)
3 Bank of Japan Act
4 Treaty establishing the European Community as revised in 1992, a.k.a Maastricht Treaty

6. plans for monetary policy (‘Humphrey Hawkins’ testimony). The Governor of the Bank of
England has to write an open letter to the Chancellor should inflation move more than one
percentage point away from the target. In addition, some executive or legislative bodies often
retain the power to reverse monetary policy decisions in extreme cases. For example in the US, a
decision by the Federal Open Market Committee can be overruled by an act of Congress. The
case of New Zealand central bank is even more straightforward. The government may remove
the government if the bank does not adequately carry out its functions or if the performance of
the governor in ensuring the Bank achieves the policy targets has been inadequate or if monetary
policy statement is inconsistent in a material respect with the Bank’s primary function or with
any policy target fixed in the Policy Agreement. As for the nomination of the governor of the
Bank of England, the Chancellor of the Exchequer has the final choice whether to follow the
Bank’s advice or to choose someone else.
Central banks are accountable to voters indirectly through their accountability to the executive
and legislative branches of government. Moreover we must not forget that democratically elected
politicians set up independent central banks of their own free will.
*
Contrary to common belief, central bank independency is legally and practically limited and
controlled. Even without these constraints, central banks need to be transparent in order to have
predictable policy. We can therefore argue that their duty requires them to be compatible with
democracy. The fact that central banks work is highly technical makes them closer to a technical
administrative bureaucracy than an independent political body.

7. Although we have seen that central banks must be independent because optimal monetary policy
isn’t the policy preferred by individuals, central banks need the public to accept the case for price
stability, the framework for achieving it, and through this the operational decisions that the
central bank takes. To achieve this, central banks must be able to explain clearly the basis of
their decisions and to have support of the politicians. Central banks therefore do press conference
to explain their decisions to the public. The Bank of England publishes economic forecasts
underpinning interest rate decisions (fan charts) The Fed and the Bank of England disclose
meetings minutes and the Fed even gives full transcripts. More importantly, the Fed and the ECB
disclose their inflation target even though they have target independence.
There is also a strong coordination between central banks and treasuries. In the United States,
there are regular common meetings and there is what Benoit Coeure calls a “pragmatic
relationship”. In Europe the coordination is still debated but ECB strictly rejects ‘ex-ante
coordination’ which it considers contrary to its independence. However the political coordination
ex post is useful so that the ECB is not seen as responsible for anything wrong happening in the
eurozone. To ensure this political support, Mario Draghi, president of the ECB recently went to
the bundestag to explain his new outright monetary transaction (OMT) programme allowing the
ECB to buy sovereign bonds on secondary markets.
The transparency required towards both the public and their elected representatives is
characteristic of democracies. It allows the public to judge whether the bank matches words with
deeds.
In normal times, monetary policy is conducted through the interest rate channel. Central banks
have reaction functions to calculate the ideal interest rate to reach their inflation target. Although

8. these reaction functions are not disclosed and have no normative value, academics have tried to
use simple thumb rules as a benchmark to assess actual interest-rate setting behavior. Taylor
(1993a) first estimated an equation relating the Fed’s behavior. The rule gave the inflation in real
terms as a linear function of the expected inflation gap and the expected output gap. He showed
that with certain parameter values, the rule provided a reasonably good description of the Fed’s
policy over the 1987–92 period. Clarida, gali and gertler also found that a simple equation did a
good job at characterizing policy during the Volcker–Greenspan era (1979:3–96:4). They argue
that central bank discretion comes mainly from the fact that parameter uncertainty requires
smoother response to inflation gap than forecasted by theory. Technical improvements in
computer calculation now aloud the use of advanced models taking into account different
rigidities (dynamic stochastic general equilibrium models).
If central bankers’ main job is to fix their refinancing interest rate following a reaction function
then we could consider them as a technical administration quite similar to a treasury. The
traditional definition of bureaucracy given by Webber (1978) is an organization with a strong
hierarchy and strict rules to fulfil official duties discharged by authority. If we think of the low
inflation goal as a duty discharged by government then central banks perfectly fit this definition.
Moreover, the fact that central bankers are come almost exclusively from the academic world
reinforces the idea that central banks are merely technical bodies with no political role. The
shortlist of candidates to become the next governor of the Bank of England is mainly composed
of economists. The MEP Shawon Bowles who is competing for the role argues in the Financial
Times that there is no need to have an “experts’ experts” and that a political figurehead with little
academic background would change the influence of the Bank.
Consistently with the model of delegated authority in a representative democracy ministers

9. delegate power to central banks in the same way they delegate power to high officials in their
administrations. In that sense, central bank independence is brought back to a classic problem of
public management. The key issue would then come down to recruitment and rewards ensuring
that central bankers have incentives not to shirk. For example paying central bankers
significantly less than their private counterpart ensures recruiting people committed to the duty
or to the prestige and not to the money. The classical literature on control over bureaucracy
would argue that central banks are relatively easy to control since their outcome can be measured
fairly precisely.
***
Academics and most politicians over the past twenty years have agreed that central banks
independence is economically and socially optimal. However this delegation leaves unelected
officials with unprecedented powers raising the issue of democratic legitimacy. I have tried to
argue that these powers can be compatible with representative democracy if central banks are
accountable to elected representatives and transparent to the public. This requires both an
institutional framework and the idea that transparency serves central banks and does not
jeopardise their independence.
A. S. Blinder summarizes the requirements for central banks not to comprise democracy: central
banks should have goals fixed by elected politicians, boards which are politically appointed;
public should get feedbacks from central banks (transparency) and politicians should have the

10. possibility to reverse monetary decisions (accountability).
I believe the common belief that central banks are non-democratic bodies is not linked to the
principle of independent central banking but comes from ideology or bad institutional
frameworks. The distrust in the Fed comes from the American fear of any bureaucracy (private
company or public administration) taking too much power at the federal level. In Europe, the
ECB does not fill all institutional requirements since nobody can overrule monetary decisions.
Moreover the growing feeling that European institutions as a whole lack democratic legitimacy
increases the critics towards the ECB.
We have seen that independent central banking does not compromise representative democracy
if institutional safeguards exist. The idea of having an economic policy out of the public debate
might seem compromising to democracy but it is not the case because monetary policy has only
short term effects. However, since the financial crisis, central banks have also started to
undertake financial stability supervision. From an ideational standpoint, this is much more
debatable because financial stability has long term effects and might have distributional effects.