Chinese President Xi Jinping bluntly asked his country’s central bank to cut the bank’s reserve requirements to reverse China’s economic slowdown fueled by its declining housing market.
Are democracies backtracking on central bank independence as well?
The central bank has meekly complied by decreasing the ratio of deposits that financial intermediaries must hold in reserves. Lowering reserve requirements increases the funding pool available to banks, putting the economy on steroids. But as growth creates inflationary pressures, lower reserve requirements put banks at risk, lest depositors want to withdraw funds. For the Chinese government, economic growth provides legitimacy. Other priorities can wait.
For example, U.S. President Joe Biden could follow Erdogan or Xi’s lead, given Biden’s sagging poll numbers and pressure from “modern monetary theory” advocates for an activist Federal Reserve. And in fact, Biden had the opportunity to move in this direction with the current Fed chair’s term slated to end in February. Yet he decided to renominate Jerome Powell, a Republican holdover from the last administration, over objection from some of his party’s senators. In his announcement renominating Powell, Biden emphasized the need for a nonpartisan independent central bank committed to its mandate.
Why then are autocracies and democracies following different central bank independence paths? The COVID-19 shock has triggered a recession accompanied by inflation. Citizens are tired of economic lockdowns and other disruptions. The short-term horizon of many citizens means government leaders are under pressure to deliver economic growth (and normalcy) quickly.
But rising inflation now puts central banks in an awkward position. Should they continue supporting government COVID-19 recovery efforts through loose money policies, or should they taper the stimulus to address inflation?
This is where the motives of autocracies and democracies diverge. Autocratic governments need to deliver short-term economic growth because they derive legitimacy not through democratic processes but by delivering prosperity (and, sometimes, by invoking nationalism). In China, for example, growth provides legitimacy to the communist regime. Indeed, the party promotes regional leaders when they deliver on economic growth promises.
Be it Chinese businessman Jack Ma or the central bank, no actor dares oppose the Chinese government
Arguably, Biden faces similar incentives https://paydayloansohio.net/cities/elyria/. Sagging poll numbers and the Democratic candidate’s loss in Virginia gubernatorial elections do not bode well for 2022 midterm elections. And even in U.S. politics, using political consultant James Carville’s famous words, the top campaign issue remains “the economy, stupid!”
What then differentiates Biden from Erdogan or Xi? Ultimately, democracies are rules-based societies. They respect institutional continuity-be it the peaceful transfer of power or central bank independence. Biden understands institutional strength as a useful tool. (The same probably does not hold for former U.S. President Donald Trump.) Moreover, Biden’s bipartisan prestige was probably enhanced when he reappointed Powell despite objections from progressives.
Inflation can become a focal event for citizens unhappy with their regime. Price hikes can trigger street demonstrations, as seen in Kazakhstan’s ongoing protests. The possibility of mass unrest is particularly important for Turkey given Erdogan’s sagging popularity. For China, a major exporting economy, inflation can erode its global competitiveness and eventually hurt its long-term economic growth.
In the months to come, rising inflation might compel Turkey and China to reinstitute central bank independence. Until then, their defections from the central bank independence mantra provide a test of whether governments can manipulate interest rates without penalties for igniting inflation.
Sandra Ahmadi is a Ph.D. student in political science and a fellow at the Center for Environmental Politics at the University of Washington in Seattle. Specializing in risk management, Ahmadi previously worked in finance for nearly 10 years. Her writing focuses on currency policy and financial markets through investigations of central banks across currency jurisdictions.