What makes a central bank ‘independent?’. As most central bank scholars and policy-makers would likely answer that question, ‘it depends’—it depends on the bank, the function it is performing, and the political-economy of the times. Still, as complicated as the concept of central bank independence is, many experts could likely agree on at least one indicium of independence: a central bank’s legal freedom to make certain decisions free from executive branch interference—at least where certain of its core functions, like monetary policy, are concerned.
In a recent article, we compare the way that two different legal frameworks—the US and the UK—legally empower their executive branches to direct or override decisions normally reserved to their independent central banks.
The analysis reveals a paradox surrounding the notion of central bank independence: Could a set of narrowly-tailored and transparent override powers that authorize a treasury, with oversight from the legislature, to direct a central bank in exigent circumstances yield a sturdier form of central bank independence than a system that establishes few or limited legal mechanisms of executive override?
The UK framework
From the UK perspective, our article examines four powers of direction that HM Treasury has over the Bank of England:
- General power of direction ‘in the public interest’ (Section 4 of the Bank of England Act 1946), introduced as part of the post-war legislation that took the Bank into public ownership in 1946. While originally sweeping in nature, monetary policy and micro-prudential supervision have subsequently been carved out from its scope.
- Reserve power over monetary policy ‘in extreme economic circumstances’ (Section 19 of the Bank of England Act 1998), retained by HM Treasury at the time the Bank of England was granted operational responsibility for monetary policy in 1998.
- Power to direct the Bank to comply with international obligations (Section 410 of the Financial Services and Markets Act 2000), which is applicable in the field of firm-specific supervision, granted in 2012.
- Power of direction where public money is at risk in a crisis (Section 61 of the Financial Services Act 2012), introduced as part of post-crisis legislative reforms and designed to put beyond doubt the chancellor of the exchequer’s ability to direct the Bank where public funds were at risk.
The article explores how the powers have changed in discrete ways at key moments in the United Kingdom’s economic history, and how they can and should be seen as a response to the unique political and economic environment and the relationship between the two institutions that prevailed at the time.
It also considers the procedural safeguards that accompany any use of these powers by HM Treasury, which vary in nature, and range from ex ante consultation with the Bank of England to ex post parliamentary approval.
In fact, it is the procedural safeguards that accompany the use of an executive override that largely determine the impact on central bank independence. In his account of how power should be delegated to independent agencies, Sir Paul Tucker, a former deputy governor of the Bank, concludes that executive overrides and agency independence are not necessarily inconsistent: ‘What matters for any override is that it be transparent, subject to legislative scrutiny, constrained by clear criteria, and in practice rare’ (Paul Tucker, Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State (2018) 125).
The article finds that three of the powers of direction score reasonably well against this standard. The 1946 power scores less well (with only a general ‘public interest’ criterion and no mandated mechanisms for scrutiny of its use)—but this has been moderated by the de jure carve-outs noted above and de facto studious restraint from HM Treasury in exercising the power.
The US framework
Turning to the US system, in US law, there are no formal legal powers of override analogous to those in the UK, which might apply generally or in regard to the Fed’s monetary policy. The closest the US comes to a general override power are section 15 and section 10(6) of the Federal Reserve Act.
Section 15 gives the US Treasury the power to ‘direct’ regional Federal Reserve banks to act as its fiscal agent. This allows the Treasury to, for example, ask the New York Fed to act as its agent in executing foreign exchange transactions, using funds from the Exchange Stabilization Fund. The power also involves the plain vanilla maintenance of the government’s bank account at the regional banks. One would be hard pressed indeed to interpret ‘direction’ in section 15 of the Federal Reserve Act to refer to any power to constrict the Fed’s independence broadly or in regard to monetary policy. Certainly, that has never been the historic usage or understanding of section 15.
Section 10(6) is more nuanced. The language of that provision, in summary, gives the Treasury the power to ‘supervise and control’ the Fed in areas where their jurisdiction overlaps. It provides that ‘wherever any power vested by this Act in the Federal Reserve Board or the Federal reserve agent appears to conflict with the powers of the Secretary of the Treasury, such powers shall be exercised subject to the supervision and control of the Secretary’ (Federal Reserve Act of 1913 § 10(6), 12 U.S.C. § 246 (2012)).
The academic literature is virtually silent about section 10(6); and it appears it has never been called upon to justify any Treasury actions. A deep-dive into the legislative history surrounding the provision suggests that it was added to the original Federal Reserve Act to appease those in Congress who feared too much monetary power would be given away to the new Federal Reserve from the Treasury.
Specifically, the legislative history shows that section 10(6) was meant to ensure the Treasury’s upper-hand in three particular situations: (1) where the comptroller of the currency (part of Treasury) was to be responsible for the issuing of national bank notes, given that the statute also required the comptroller to answer to both the treasury secretary and the new board; (2) where the comptroller would be responsible for setting quality standards for national banks, which would then become member banks in the new Federal Reserve System; and (3) regarding the decision whether to continue using the sub-treasury system for the deposit of public funds, or switch the government’s bank account to the new Federal Reserve regional banks.
Of course, with the disappearance of national bank notes, the largely settled membership of the Federal Reserve System, and the abolition of the sub-treasury system, section 10(6) would seem moot to the original purposes for which it was intended. Indeed, Congress in 1956 recommended that 10(6) be deleted as ‘obsolete’. For some reason, that recommendation was not taken. Even so, while Treasury’s power to ‘supervise and control’ the Fed still exists—and remains unmoored from statutory criteria constraining its actual use—, the legislative history does make plain that it was never intended as an instrument for influencing the Fed’s monetary policy.
But the absence of formal legal powers of override has not meant a politically insulated Fed. Instead, history provides several examples in which the Treasury, or the president, sought to influence or control the Fed’s monetary policy.
Our Article discusses several examples of this kind of informal, de facto pressure. The earliest examples relate to the bond-buying programs run by the government during both world wars. After the wars, the clearest examples of such informal pressure appear in the relationships between the US president and the Fed chairs (a result, we conjecture, of the formalized Fed-Treasury Accord of 1951 which put more pressure on a visibly hands-off Treasury). The article discusses, as a few examples, President Lyndon Johnson’s no-holds-barred style pressuring of William McChesney Martin (‘my boys are dying in Vietnam and you won’t print the money I need’); President Richard Nixon caught on tape in 1971 telling Fed Chair Arthur Burns to ‘kick ‘em in the rump a little’ (referring to the FOMC and the discount rate); and President Donald Trump publicly criticizing Fed Chairman Jay Powell’s decisions to raise rates in 2019.
Central bank independence is as much a matter of practice and custom as it is of law. The relationship between any nation’s executive branch and its central bank will have developed organically over time, reflecting the constitutional traditions of that system of government and the prevailing political and economic circumstances.
Against this background, our article provides an in-depth comparison of the executive override powers available to HM Treasury over the Bank of England on the one hand, and the US Treasury over the Federal Reserve on the other.
It finds that the UK framework sets out prescribed powers on a statutory basis, in an established and transparent legal framework. The US framework, in contrast, is more informal, based on ad hoc convention and subject to less formal oversight.
Our article suggests that the US might consider whether some aspects of the UK design would augment the institutional independence of the Fed, and considers in particular the ability to exercise some power of direction in times of emergency and in the interest of financial stability. More broadly, the article offers scholars and policymakers alike a new lens through which they can view the question of central bank independence.
Christina Skinner is Assistant Professor of Legal Studies & Business Ethics at the Wharton School, University of Pennsylvania.
Michael Salib is a lawyer at the Bank of England.
This post first appeared on the Columbia Law School Blue Sky blog here.
The post and the article are written in Mr Salib’s personal capacity and do not purport to represent the views of the Bank of England.