The Smile of the Cheshire Cat: Central Bank Independence after the Crisis

The financial crisis has cast new light on central banking by showing how the central bank may need fiscal backing in order to stabilise financial markets. Furthermore, central banks have found that large-scale purchases of government bonds, going far beyond normal open market operations, are needed to facilitate the conduct of monetary policy. From both these perspectives, it is hard to describe central banks as ‘independent’ any more. But independence has ended in a somewhat unexpected way: instead of governments making demands on central banks, central banks need governments to support them. This was not foreseen in any of the models about the interaction of monetary policy with the economy, be it with fiscal policy or with coordinated wage bargains. Taking the examples of the Fed, the Bank of England and the ECB, we show that the loss of independence has not had serious political consequences except for the ECB, which has no government it can rely upon. We suggest that, while independence may have been nontrivial in the past, the conditions under which it matters may well not (re)occur for many years. The support that is required is compatible with existing governance arrangements in the US and UK, so the formal abandonment of CBI is not needed: the smile can stay, even though the cat has vanished. However, the euro area lacks institutions for monetary-fiscal cooperation, leaving the cat all too visible and exposed.