Is Central Bank Independence Necessarily a Good Thing?

On 2 May 1997, the British Labour Party won a landslide election victory, sweeping away 18 years of Conservative rule. Rather like today’s Congress-led government in New Delhi, the air of “l’ancien regime” hung over the last few years of John Major’s government. Previously seen as having a safe pair of hands, the Conservative Party lost economic credibility four years earlier at 4 pm on 15 September 1992, when the sterling was rudely ejected from Europe’s Exchange Rate Mechanism. The United Kingdom government lost credibility in that event.

On 2 May 1997, the British Labour Party won a landslide election victory, sweeping away 18 years of Conservative rule. Rather like today’s Congress-led government in New Delhi, the air of “l’ancien regime” hung over the last few years of John Major’s government. Previously seen as having a safe pair of hands, the Conservative Party lost economic credibility four years earlier at 4 pm on 15 September 1992, when the sterling was rudely ejected from Europe’s Exchange Rate Mechanism. The United Kingdom government lost credibility in that event. While the economy recovered, the Conservative’s credibility did not. Instead, the media scented wounded prey. They had a field day over a deepening quagmire of moral indiscretions by Conservative MPs and a litany of corruption allegations. At the same time a new breed of Labour leaders had emerged, tired of the political wilderness and content to slaughter sacred cows in the pursuit of power. Tony Blair and Gordon Brown cozied up to the Murdoch press, supped with London’s financiers and ditched “Clause 4” of Labour’s 1918 constitution, which called for “common ownership” of the means of production and distribution. The British Tories are hardly the Congress of India, but there are a number of parallels between the political dynamics of Britain in 1997 and India in 2014.

Four days after sweeping to power Chancellor Gordon Brown announced the independence of the Bank of England, stripped it of its regulatory and debt management functions and established a new super-regulator and debt office. With that dramatic entrance, Labour’s economic credibility rode high for 10 years, only diminished by the “Great Credit Crunch” of 2007. Many urge the next government in New Delhi to add immediate credibility to campaign claims of reformist zeal and greater decisiveness by making the Reserve Bank of India (RBI) independent and putting its regulatory and debt management powers in separate, independent, institutions. Would that be a good idea?