Independence of global central banks coming under increasing stress

There are growing risks to central bank independence in a number of countries and the current mood marks "only the beginning" of an extended macro policy debate that is likely to play out in the years ahead, especially where economic growth is slowing, according to a leading rating agency.

In report for its clients, Fitch Ratings said in emerging and developed markets alike, strong central bank balance sheets (generating seigniorage profits) compared with those of governments, combined with well-earned central bank policy credibility in many jurisdictions, are attracting the attention of fiscal policymakers.

“Fitch believes investors would be wise to consider the potential implications of mounting political pressures for greater contributions from monetary policy to support economic growth, possibly by unconventional means.”

For instance, in the US there is growing support for the notion that with the dollar being the preeminent global reserve currency and Treasury securities concomitantly the world's most sought-after risk-free asset, there is an “opportunity to fund increased government spending” with the creation of money, for which there is essentially unlimited demand.

The rating agency said there is one overriding problem with the Modern Monetary Theory (MMT) discussion in the US. “As many governments in other countries have previously discovered, assuming unwavering demand for a currency undergoing a large or sustained increase in supply goes against the basic tenets of price stability and rational investor choice.”

Central banking with fiat money is based on confidence above all else, Fitch opined. 

“Confidence in turn relies on robust balance sheets and prudence in managing all aspects of central bank finances and areas of policy responsibility. The current combination in some countries of balance sheets that are strong for central banks and weak for governments is worrying where fiscal policymakers are looking to central banks as part of their solution.”

Of course, the risk is central bank balance sheets are then also weakened, and confidence ebbs. The benefits of lower inflation could be jeopardised, and, in the case of the US, the specific advantages of hosting the world's reserve currency and risk-free asset could be diminished, Fitch added.

Central banks may have the upper hand in terms of policy credibility in the debate that has already started, but governments more often have the legal authority to impose their will.

“While the US is a considerable distance from adopting MMT as envisioned by its supporters, pressures on the central bank there and elsewhere will be growing in the period ahead,” the agency concluded.