Central Bank Independence

I remember a worksheet my teacher gave us in early elementary school called "Smiley Words and Frowny Words." We had a vocabulary list and were supposed to draw the appropriate smiley or frowny face to match the positive or negative connotation of the word. Most of the words-- freedom, fortune, distress-- had definitely positive or definitely negative connotation. But I remember being puzzled when I started trying to classify all the other words I could think of, and most seemed neither smiley nor frowny. Some words have emotions already attached, but the vast majority have a neutral connotation, and gain meaning only from context. This was astounding to me as a seven year old, and may explain some part of why I became a scientist and a writer, and my approach to both of those roles.

In my last post I wrote about a threat to central bank independence in Japan. At least, that is how it was phrased in all of the news articles that covered the story. None of the articles explained what central bank independence actually means, or why it matters. But at least to American ears, independence is a happy word. For anyone who went through the American school system, the word brings about a mental image along the lines of Thomas Jefferson waving the Star Spangled Banner while an eagle soars overhead. Oh, and plenty of fireworks. Yes, independence sounds good, and a threat to independence sounds like something we should be very angry about.

But when it comes to central banks, the concept of independence should, a priori, be neutral. Economists don't actually have conclusive evidence about whether or not central bank independence is beneficial-- probably in some cases it is, and in some cases it isn't, and it all depends on how you want to define independence and beneficial. I listened to some top economists discuss the matter for four hours on Friday, at two sessions of the American Economics Association conference, and reach no strong consensus. After one of the sessions, Fox almost instantly published an article crying  that "Central banks have sacrificed some of their cherished political independence."

The article makes no indication that this cherished political independence is of questionable value. Nobel Prize winner Joseph Stiglitz has remarked that
"...one of the central principles advocated by Western central bankers- the desirability of central bank independence-was questionable at best…In the crisis, countries with less independent central banks-China, India, and Brazil-did far, far better than countries with more independent central banks, Europe and the United States. There is no such thing as truly independent institutions. All public institutions are accountable, and the only question is to whom."
The issue of central bank independence is very relevant right now, not just for Japan but also for the United States, India, and much of Europe. I think, because of the connotation of the word independence, that people will just assume that more independence is better. And it really does matter what the public thinks, since this is a highly political issue. What we really need is central bank effectiveness, and in some cases that may come from more cooperation with other parts of government. In Japan, where inflation is too low, the new Prime Minister Shinzo Abe is pressuring the Bank of Japan to share a 2 percent inflation target with the government. The Bank of Japan will vote on the new target on January 21-22. A united front by the Bank and the government might be just the ticket to making the inflation target credible and reviving the long-suffering Japanese economy. 

I may write more about central bank independence in a future post, but the point I really want to make is that the economy depends on policies and politics, which depend on public perceptions. And as much as economists would like to believe that people are all perfectly rational and attentive decision-makers, really almost all of us make a lot of decisions really quickly, based on gut responses emotional reactions. We skim an article and make a smiley face or a frowny face. That's not a bad thing; gut responses and emotional responses make life worth living. It is just something economists and readers of economics need to be aware of, and part of the reason why it is so important for economists to learn to communicate better.

Communication about economics the topic of a panel discussion I attended yesterday called "Models or Muddles: How the Press Covers Economics and the Economy." Some of the biggest names in economic journalism were there-- Tyler Cowen, Adam Davidson, Kelly Evans, Chrystia Freeland, and David Wessel. Adam Davidson, from NPR's Planet Money, talked about the craft of making an emotionally compelling narrative in economic journalism while remaining intellectually upright. He mentioned how a story about the housing crisis, for example, should have a human element but shouldn't feature the "most sad-sack" person you can find just to make the banks seem evil. I couldn't agree more.