Silent Power Games: Addressing the Challenges and Invisible Hands Behind Central Banks Aiming for Autonomy

Central banks are major players in the financial market; their role is to control the sector and carry out their missions. Their mandates differ depending on the structure of the central bank’s monetary policy.

Central banks around the world strive to ensure price and financial stability. Many central banks, including the US Federal Reserve, claim independence from external pressures, meaning they can make monetary policy choices without political interference. This also means separating monetary policy from fiscal policy to prevent politicians from manipulating inflation to reduce the real value of government debt.

Without this independence, a heavily indebted government might be tempted to influence the central bank to create inflationary conditions. This inflation reduces the real value of the currency, making future debt repayments more affordable, but at the expense of economic stability and public confidence in the currency. On the other hand, some central banks have decided that independence is ineffective for their economic structure.

So are these claims true? Is a central bank really immune to such violations?

To successfully address these issues, many essential elements of independence need to be addressed, including political independence, operational independence and financial market independence.

Many claim that central banks act independently of political considerations and make decisions based solely on economic data and unbiased research. However, the reality of central bank governor appointments often contradicts this premise. Typically, the government has the power to appoint the central bank governor. This implies that the government could choose a governor who aligns with its own political or economic goals, undermining the central bank’s stated independence.

The influence of monetary policy is particularly strong when the governor’s term is short, forcing him to adopt policies that will win the government’s favor in order to be reappointed. This process can quietly force the central bank to support government policies that are inconsistent with what is economically prudent, thereby undermining the institution’s effective independence.

For example, when a president openly orders the central bank to cut interest rates in order to stimulate economic growth, even if this contradicts the central bank’s objective, this demonstrates a clear lack of independence.

But the story does not end there. We still need to look at the second important point, namely operational independence. This means that the central bank must be able to use whatever instruments it wants and control its own balance sheet independently of external factors.

To support their claim to independence, one must examine the main accounts on their balance sheet, which include “assets,” the majority of which are securities, and “liabilities,” the majority of which are reserves.

To begin with, they hold securities, usually government bonds, often called risk-free, in order to conduct open market operations, which are critical activities. This involves buying and selling financial instruments to inject or subtract funds in order to influence the economy.

The government issues these debt instruments, which means that it has influence over one of the central bank’s most essential tools. This suggests a potential conflict between the central bank’s objectives of price stability, financial stability, monetary policy, and independence and the government’s objectives of supporting economic growth and fiscal stability through government spending and taxes. The government, which owns and issues this tool, can use it to pursue its own objectives and meet its financial obligations, which creates a conflict of interest.

In the event of a deficit, the government can issue bonds to borrow from the central bank and finance the deficit. The Qatari government is in surplus and does not need to issue debt securities to borrow from the central bank; however, it does so primarily for the benefit of the central bank’s open market operations.

Moreover, although independence and separation of fiscal and monetary policies are essential, the government generally prioritizes its own interests over those of the central bank. It can use these debt instruments to finance its deficits and, in case of excess, it may not issue these bonds, which limits the decision-making power of the central bank, especially in times of financial instability.

This suggests that without coordination between fiscal and monetary policies, managing public finances can be difficult. This case clearly shows that effective coordination of different programs is often preferable to separating them. The central bank owns reserves, the second largest liability component of the balance sheet, which are bank deposits. Large banks, which hold the majority of these reserves, have the greatest decision-making power over them, which allows them to influence the central bank’s decisions.

We will now answer the last question concerning the independence of central banks: are these institutions really independent from the financial markets?

This topic requires us to study the role of important market players, especially large banks. Although I have already stated that large banks have an influence on central bank policies, it is essential to recognize that they also dominate financial markets and have a significant impact on the economy. In addition, central banks sometimes have to coordinate their activities with market trends.

In this regard, large institutions, such as major banks with considerable capital and influence, play a critical role. For example, the US Federal Reserve would likely have to step in to prevent widespread economic disruption if a large institution like JP Morgan were to face extreme difficulties or potential bankruptcy. Moreover, these financial giants can respond to central bank policies in ways that encourage the broader market to put pressure on central banks.

This pressure can force central banks to pursue policies that deviate from their stated missions, offering short-term gains but posing long-term risks, such as asset bubble inflation, in which asset prices rise significantly above their intrinsic value.

These huge institutions (the big banks) have the ability to engage directly with legislators and even conduct public campaigns (lobbying). An example of lobbying is assuming that the central bank continues to raise interest rates, which banks do not like because it increases the cost of borrowing. These banks can pressure central banks to lower interest rates, even if it means jeopardizing the autonomy of the central bank.

Finally, central banks seek financial stability, occasionally intervening in financial markets or providing liquidity to prevent large-scale disasters. For example, central banks want to raise interest rates, but they fear financial instability (stock market crashes). This interference reduces their autonomy because they depend on financial market conditions.

Arguments about the independence of central banks are clearly false, as they are not fully independent. However, this is not a negative aspect, as central banks collaborate with the government’s fiscal policy to achieve objectives that benefit both parties.

But if they want full independence, the laws of the country must support and fully empower them, which is not necessary in my opinion, because central banks can collaborate with the government, which is more useful in my opinion and can lead to more positive results. Also, trying to align with the needs of the financial market is not a bad thing, but they must assess what they deem appropriate to avoid bubbles (which can trigger crises).

Abdulla Ali Abdulla al-Siddiqi al-Emadi is an honors student in finance and economics at Qatar University.