Banking on Reform: Political Parties and Central Bank Independence in the Industrial Democracies by William Bernhard

CHAPTER 1
Political Parties and
Central Bank Independence
Central banks stand at the intersection of economics and politics. These
bureaucratic institutions implement monetary policy by regulating the
supply of money and credit to the economy. Both academic and popular
accounts emphasize how a country’s central bank significantly shapes its
economic destiny (e.g., Beckner 1996; Deane and Pringle 1995; Greider
1987; Marsh 1992). In many countries, opinion polls and newspaper stories
recognize central bankers as the most influential nonelected public officials.
Although central banks perform a similar function across the industrial
democracies, their institutional structures—their levels of independence—
differ across systems. The structure of an independent central bank restricts
the government’s ex-ante and ex-post influence over monetary policy, often
by limiting the number of cabinet appointees on a bank’s governing board,
by preventing the cabinet from vetoing the bank’s policy decisions, and by
prohibiting the cabinet from punishing central bankers through dismissal or
budget cuts. A dependent central bank, on the other hand, places few
limitations on the government’s authority.
In the 1970s and 1980s, only a few central banks were independent; the
majority of industrial democracies had dependent central banks. In the
1990s, however, this distribution shifted significantly as many countries
legislated more independence for their central banks. Most dramatically,
European Union (EU) member states agreed to a single currency under the
administration of an independent central bank. In this book, I explain these
patterns of central bank independence.
Central Bank Independence: The Reform Trend
Throughout most of the post–World War II period, only a few industrial
democracies, including Germany, Switzerland, and the United States,
possessed independent central banks. The German Bundesbank, for
example, is generally recognized as one of the most independent central
banks in the world (Deutsche Bundesbank 1989; Goodman 1992; Kennedy
1991; Marsh 1992; Sturm 1989). The German federal government appoints
only a minority of the Central Bank Council, the bank’s main decision-

making body. Further, the government cannot veto the bank’s decisions,
although it may delay for two weeks the implementation of a bank decision.
In countries such as Britain, Italy, and France, on the other hand, the
government retained full control over the central bank’s policy actions. In
Britain, for example, the government appointed the entire governing board
and could veto the bank’s policy decisions. The Treasury dictated the Bank
of England’s policies (Fay 1988). Nigel Lawson, a former chancellor of the
Exchequer, described the relationship between the government and the bank
in this way, “I make the decisions and the Bank carries them out” (The
Economist, 10 February 1990).
Many economists and policymakers argue that an independent central
bank insulates monetary policy from political influences to produce more
stable and predictable monetary policies and as a result, lower levels of
inflation. Indeed, countries with an independent central bank generally had
better inflation performance during the 1970s and 1980s than countries with
a dependent central bank. Yet during this time, no country moved to make
its central bank more independent.
In the late 1980s and 1990s, however, a wave of central bank reform
swept across the industrial democracies. Politicians in Italy and New
Zealand made the earliest efforts to grant their central banks more
independence. In Italy a 1981 administrative decree freed the Bank of Italy
from its obligation to purchase unsold public debt, an act known as the

Banking on Reform: Political Parties and Central Bank Independence in the Industrial Democracies by William Bernhard