Central bank independence has been a pillar of economic stability for the past decades. Although legal safeguards have strengthened, they have not always been sufficient to ensure de facto independence, as was evident in Turkey. Despite their past successes, central banks are likely to face increased political pressure.
President Trump has already taken steps to undermine the Fed’s independence. Growing populism, high public debt and negative supply shocks will likely intensify this trend. Financial markets may act as an important guardrail but even institutions with strong legal frameworks are not immune. Independence not only relies on law, but also on credibility and political norms. What was once taken for granted is now being tested.
Independent central banks deliver better economic outcomes
Central bank independence has underpinned macroeconomic stability for much of the past four decades. Economists have long shown that it keeps inflation lower and steadier without hurting growth. Over the years, both advanced and emerging market economies have beefed up legal protections to keep politics out of monetary policy.
De jure independence does not guarantee de facto independence
But legal guarantees do not make central banks immune from pressure. Politicians almost always want lower rates. Turkey is a textbook case. It scores well on formal independence. Yet President Erdogan spent years intimidating the central bank to slash rates ahead of his re-election, fuelling inflation. America is now testing some of the same boundaries. President Trump has leaned on the Fed harder than any president since Nixon. His attempt to sack Governor Cook – widely seen as unlawful – is one of the most significant threats to the Fed’s de facto independence in half a century. How the Supreme Court rules on that dismissal will show whether America’s institutional guardrails still hold. Anything short of a clear ruling that ties presidents’ hands could shake confidence in the Fed’s autonomy.
Political pressure is likely to grow
The deeper worry is that this is not a blip. Rising populism, swelling deficits and public debts, and more frequent negative supply shocks are likely to bring more political interference, not less. Financial markets will be crucial in pushing back – but they may not always succeed.
What independence means
Central banks are not fully sovereign. Parliaments or treaties set their objectives – typically price stability, and in America’s case also maximum employment. But central banks tend to define those goals, decide how to meet them, but must explain themselves to legislators through frequent testimonies. Independence is usually defined along four lines. Firstly, goal independence, defining what ‘price stability’ means – often a 2% inflation target. Secondly, instrument independence, choosing the policy tools to reach it, from interest rates to balance-sheet operations. Thirdly, financial independence, controlling their own budget. Central banks generate income through seigniorage, insulating them from fiscal politics. Fourthly, personal independence, protecting leaders from arbitrary dismissal.
Economists have turned these features into indices of de jure independence. The most cited, developed by Alex Cukierman in 1992 and later expanded and updated by Garriga, Romelli and Adrian, scores central banks from 0 to 1 – they are based on 6 sub-indicators, which themselves aggregate answers to a number of questions. Over time, these scores have climbed in both advanced and emerging economies.
Indices not an accurate reflection of independence
Yet the numbers can mislead. The Fed scores lower than most large central banks, largely because it doesn’t have a single mandate prioritising price stability, but a dual mandate that could involve trade-offs when those two goals are in tension, as is the case right now. Moreover, unlike the ECB, the Fed does not have a legally watertight framework to guarantee that the executive branch cannot control the board of governors. More broadly, the Fed operates under a more flexible legal framework. Still, the fact that Turkey’s or China’s central bank scores higher than the Fed says more about legal form than political reality.
Actual independence depends as much on reputation, credibility and political norms as on statutes. These are harder to measure but can be inferred from governor turnover rates, inflation expectations, exchange rates and term premia. Emerging market central banks have improved on these fronts since the 1990s: illegal dismissals have fallen, and inflation expectations are better anchored. This, for example, gave them room to support their economies during the pandemic. The Fed, too, has long enjoyed strong de facto independence. Its credibility was cemented after it waged a war on inflation in the 1970s, after President Nixon pressured the then head of the Fed Arthur Burns into lowering rates to facilitate his re-election.
President Trump has broken well established norms
Still, when independence is not deeply rooted in law, political norms, such as the executive branch refraining from publicly commenting on monetary policy and the central bank on fiscal policy, matter a lot but can be broken, too. Under Trump’s first term, his relentless Twitter attacks on the Fed moved markets. Research by Bianchi and co-authors finds that his public pressure lowered expectations for future rates – possibly influencing the Fed itself. In his second term, Trump has gone further, using the executive branch, as well as the legal space, to attempt to discredit board members and replace them with loyalists. The fact that measures of long-term inflation expectations have edged up since his re-election signals some erosion of trust.
Political pressure on central banks to grow
Three forces could intensify such pressure on central banks, with those in advanced economies with lower de jure independence – Bank of Japan, Bank of England and the Fed – perhaps more at risk.
Growing populism
Firstly, populism. While every government tends to always prefer lower rates, populists are more likely to attack central banks openly. It fits their playbook: railing against technocrats in the name of ‘the people’. In a recent paper, Gavin and Manger show that populists are more likely to obtain interest rate concessions, though financial markets can play an important role in constraining those demands.
Historically elevated public debt
Secondly, fiscal dominance. Historically high public debt and large deficits across advanced economies make inflation politically tempting. Ageing populations, rising defence spending needs and climate costs will stretch budgets further. History shows that, when fiscal pressures mount, governments lean on central banks to inflate their way out or use financial repression to keep interest rate payments low.
Negative supply shocks
Thirdly, negative supply shocks. The world is moving from an era of abundant supply to one of frequent disruptions – climate shocks, geopolitical fragmentation and energy insecurity. Such shocks push up prices but slow growth. Central banks cannot fix them but may get the blame, weakening their legitimacy and inviting interference.
Financial markets can act as an important guardrail
Markets can act as an important guardrail. And central banks, such as the ECB, with clear mandates, legal protection and deep credibility are harder to bully. But no central bank operates in a political vacuum. A cornerstone of modern economic policy could yet be chipped away.
By Raphael Olszyna-Marzys, international economist at J. Safra Sarasin Sustainable Asset Management
