Date published: May 2018
SUERF Policy Note, Issue No 32
by Charles Goodhart, London School of Economics and Rosa Lastra, Queen Mary University of London
Download: SUERF Policy Note, Issue No 32 (0.76 MB)
Independence and Accountability
Independence in the context of central banking is not absolute, but relative. Independence is freedom from political instruction on the one hand and from financial markets on the other hand (the central bank acts in the public interest while financial market participants are driven by private interests). This double dimension goes hand in hand with their dual role as government’s bank and bankers’ bank. However, what is considered to be ‘lack of dependence’ has nuances across central banks, across jurisdictions, across time and across functions. Between full independence and full dependence there is a gradation with various degrees of operational autonomy (etymologically autonomy means the ability to give norms to itself) and control.
Accountability is not simply an ‘add-on’ to justify independence. Hence the term ‘accountable independence’.2 Accountability - ex ante and ex post - is a constitutive part of the design of an independent agency in a democratic system, whose aim is to bring back the central bank to the system of checks and balances, (trias politica).
[I]ndependence is only one side of the coin, for in a democratic community accountability is also necessary. Such accountability should be diversified, dispersed through the three branches of the state, through institutions with differing obligations to the electorate hereby granting the democratic legitimacy that an independent central bank would otherwise lack. This institutional articulation of accountability should be complement ed by other forms of accountability, namely public support, disclosure and performance control (…). The optimal trade-off between independence and accountability varies from country to country.3
Accountability does not necessarily politicize a central bank, rather it means that the central bank should provide a justification of its actions. The design of accountable independence is a balancing act. Too much independence leads to an undesirable state within the state. Too much accountability threatens the effectiveness of independence. When Parliament is dominated by the executive branch of government or when parliamentary accountability is limited we must rely also on other mechanisms to hold the central bank to account.
A central bank, lest we forget, is both an agency and a bank4 and, thus, it needs a special accountability regime.
Legitimacy and Accountability
Legitimacy pre-exists and is a requisite of accountability. Legitimacy in turn is rooted in the concept of sovereignty.5 There are two aspects to legitimacy: formal and societal.6 According to the former, the creation of an independent central bank must be the fruit of a democratic act: an act of the legislator, a constitutional decision or a treaty provision. (Non-democratic regimes also have a notion of formal legitimacy embedded in their systems). ‘Societal’ legitimacy refers to the support by the public, and is determined by the acceptance of or loyalty to the system. Of course, societal legitimacy can be fickle since public acceptance is also influenced by politics, the media, current events, change in circumstances, sentiment, and others factors. In any case, when societal legitimacy weakens or is no longer present, the law is bound to change.
Any democratic regime can alter the mandate of the central bank following the required normative procedure (a statute for example can always be replaced by another statute; Constitutions and Treaties are more difficult to revise, but they are not immutable).
While the initial legal basis ‘legitimizes’ the establishment of the independent central bank, it cannot by itself legitimize on an ongoing basis the exercise of the powers delegated to such agency. It is then in the continuing life of that entity that accountability becomes necessary to ensure legitimacy. An accountable central bank must give account, explain and justify the actions or decisions taken, against criteria of some kind, and take responsibility for any fault or damage.
Compared with other government agencies, central banks are very powerful entities since they are guardians of monetary stability (and financial stability) and dictate price levels, influencing the level of risk-taking in the economy.7 Central banks’ monetary policies also have important redistributive effects. That is why accountability is of the essence.
As the mandate has become fuzzier, broader and more complicated – with unconventional monetary policies and the renewed emphasis on financial stability – the consensus which surrounds the goal/s crumbles and with it the importance of independence diminishes.8 The delegation of macro-prudential supervision and financial stability to the central bank could become more problematical than inflation targetry, because it is so much harder to monitor, and you cannot really tell whether the authorities are on the right track or not. It is remarkable: (1) that almost all of the criticism of CBs relates to their monetary policy actions, rather than giving them extra powers to achieve financial stability, and (2) that CBs have also been the ‘only game in town’,9 so one might have expected inactivity in fiscal policy and supply side measures to have been more vocal, whereas the criticism seems to be focussed on the only institution trying to do much. Moreover, an independent central bank – as a specialised technocratic agency – operating without electoral or partisan influences or constraints can do a better job at preserving monetary and financial stability than a political authority that seeks re-election and is thus subject to time inconsistency problems.
The question of excessive reach, that is whether central banks have abrogated to themselves powers which are not in the mandate, and the legal interpretation of whether a central bank is abiding by the mandate or exceeding its powers, are fundamental issues in a democratic system.
What is clear is that if the mandate gets overstretched the balance between independence and accountability should tilt towards accountability. This can take many forms: additional disclosure requirements, further parliamentary oversight and judicial scrutiny. And ultimately a change in the law – reflecting the expanded mandate – might be the right course of action in a democracy, since any expansive interpretation of delegated central bank powers within a given legal structure should be limited in time.
An accountable central bank should be judged for the reasonableness of its actions, by Parliament, by the executive, by the public and of course by the competent Courts of Justice. While the debate on accountability has focused primarily on parliamentary scrutiny, performance control and transparency, in the ensuing section we focus on judicial review.
The judicial review of administrative actions to prevent an arbitrary and unreasonable exercise of discretionary authority is an important element of the rule of law.10 That the judiciary should control the lawfulness of the central bank’s actions and decisions in the fulfilment of its functions should be beyond question.
Up until the global financial crisis, courts dealt sparsely with central banking actions and decisions. In the USA, there is no mechanism to review the monetary policy actions and decisions of the Federal Reserve System,11 though the Fed’s actions and decisions concerning supervision, financial stability and payment systems are subject to judicial review. In the UK, the Northern Rock case led to a lively debate about discretion, financial stability and moral hazard with regard to the LOLR of the Bank of England.12 However, in the EU, with the Pringle case13 and the Gauweiler case,14 the role of supreme court judges in the formation of economic and monetary policy has become the subject of heated legal and political debate.
When reviewing central bank policies or decisions to assess whether or not a central bank has exceeded its powers, the competent Courts (in the case of the ECB only the Court of Justice of the European Union is competent) may exercise judicial restraint – deferring to central bank discretion and expertise – or more robust judicial control.
While judicial restraint is justifiable in the presence of other strong mechanisms of accountability, notably parliamentary scrutiny, one should question whether it may be less justifiable when judicial review emerges as the main mechanism of scrutinising the domain of expanded central bank powers and assessing whether or not they have exceeded their legal mandates.
Central bank discretion (a key component of independence) is the freedom to act within a legal framework. Judicial review does not extend to the ‘content of the decision’ (the aim of the Court is not to supplant or replace the decision taken), but it does extend to the parameters and legal framework that surround such decision in order to determine whether or not the central bank mandate has been exceeded.15 For example, discretion in the context of monetary policy means that the central bank can choose whichever monetary policy instrument it deems appropriate in the pursuit of the goal; discretion also means that the central bank can define what a generic goal such as price stability actually means. The content of such discretionary decision is not reviewable. Discretion in the context of ELA, means that National Central Banks (NCBs) acting as LOLR in bilateral lending operations (market liquidity assistance via open market operations is the responsibility of the ECB) can choose to provide assistance or not to a credit institution (at their own risk and liability), but they must act in accordance with the Treaty provisions (notably Article 123 on the prohibition of monetary financing), the ECB Emergency liquidity assistance (ELA) procedures16 and EU state aid rules.
During the twin financial and sovereign debt crisis in the eurozone, the ECB expanded its toolkit of monetary policy instruments into ‘unconventional measures.’ One of those measures was the Outright Monetary Transactions programme (which was never activated).17 The legality of OMT was challenged18 by some German citizens (Gauweiler and others) in the German Federal Constitutional Court, Bundesverfassungsgericht, which referred the case to the Court of Justice of the European Union (CJUE) for a preliminary ruling to determine whether the ECB had exceeded its mandate, acting ultra vires, with this announcement. The CJEU made its final ruling in June 2015, declaring the conditional OMT programme to be legal, since it ‘does not exceed the powers of the ECB in relation to monetary policy and does not contravene the prohibition of monetary financing of EU nations’.19 The CJEU focused on the objectives of monetary policy rather than the effects of the measures under review.20
A key feature in the Gauweiler case is the deference to the broad discretion of the ECB. As Advocate General Cruz Villalón stated in his Opinion:
The ECB must accordingly be afforded a broad discretion for the purpose of framing and implementing the Union’s monetary policy. The Courts, when reviewing the ECB’s activity, must therefore avoid the risk of supplanting the Bank, by venturing into a highly technical terrain in which it is necessary to have an expertise and experience which, according to the Treaties, devolves solely upon the ECB. Therefore, the intensity of judicial review of the ECB’s activity, its mandatory nature aside, must be characterised by a considerable degree of caution.21
The risk of ‘supplanting the Bank’ justifies the ‘degree of caution’ that should characterize the intensity of judicial review.22 “Judges should not overstep the limits of their competences in order to enforce the limits of other actors’ competences.”23 However, the deference to the ECB’s ‘broad discretion’ on the basis of the latter’s experience and technical expertise strengthens the case for expertise and adequate preparation of the judges that will assess those complex issues. This happens in other areas of economic regulation. Judicial activism has be-come the norm in the field of EU competition policy.
It can be argued that expanding judicial review of monetary policy decisions requires more than a growth in judi-cial CB expertise because, as Will Bateman indicated in comments to our paper,24 common law judiciaries avoid judicially reviewing government functions with high-stakes macroeconomic consequences and tend to focus on issues of procedural justice or fairness rather than redistributive justice.25
US Supreme Court Justice Stephen Breyer has argued that it is not possible to understand and evaluate what agencies do without having some sense of the regulatory policy as well.26 The need for specific expertise when it comes to the adjudication of complex financial and monetary matters is a relevant issue not only for the CJEU but also, for example, for the UK Supreme Court. If judicial restraint in monetary matters is advocated on the basis of [limited] technical expertise and qualifications of the judges adjudicating such matters,27 the counter-argument to not ‘being equipped’ is to actually equip judges.
Given the specificity and complexity of monetary policy and other central banking functions (and the added diffi-culty in the EU context of determining whether a measure is of monetary policy – an exclusive competence of the Union – or economic policy28) and considering that only the CJEU can judge the ECB (Article 35 ESCB Statute), the need for competence and expertise in the exercise of judicial review could be served by the establishment of a specialised chamber within the CJEU to deal with these issues. Having dedicated specialised judges with expertise in financial and monetary matters when adjudicating cases related to the ECB would enhance the legal frame-work of ECB accountability in light of the significantly expanded mandate of the ECB.
About the authors
Charles Goodhart, CBE, FBA is Emeritus Professor of Banking and Finance with the Financial Markets Group at the London School of Economics, having previously, 1987-2005, been its Deputy Director. Until his retirement in 2002, he had been the Norman Sosnow Professor of Banking and Finance at LSE since 1985. Before then, he had worked at the Bank of England for seventeen years as a monetary adviser, becoming a Chief Adviser in 1980. In 1997, he was appointed one of the outside independent members of the Bank of England’s new Monetary Policy Committee until May 2000. Earlier he had taught at Cambridge and LSE. Besides numerous articles, he has written a couple of books on monetary history; a graduate monetary textbook, Money, Informati-on and Uncertainty (2nd Ed. 1989); two collections of papers on monetary policy, Monetary Theory and Practice (1984) and The Central Bank and The Financial System (1995); and a number of books and articles on Financial Stability, on which subject he was Adviser to the Governor of the Bank of England, 2002-2004, and numerous other studies relating to financial markets and to monetary policy and history. His latest books include The Basel Committee on Banking Supervision: A History of the Early Years, 1974-1997 (2011), and The Regulatory Response to the Financial Crisis (2009).
Rosa María Lastra is Professor in International Financial and Monetary Law at the Centre for Commercial Law Studies (CCLS), Queen Mary University of London. She is a member of Monetary Committee of the International Law Association (MOCOMILA), a founding member of the European Shadow Financial Regulatory Committee (ESFRC), and an associate of the Financial Markets Group of the London School of Economics and Political Science. She has served as a consultant to the International Monetary Fund, the European Central Bank, the World Bank, the Asian Development Bank and the Federal Reserve Bank of New York and the UK House of Lords. Since 2015 she serves as a member of the Monetary Expert Panel of the European Parliament. Since 2016 she also serves as member of the Banking Union (Resolution) Expert Panel of the European Parliament. Her publications include numerous articles in internationally refereed journals and several books including International Financial and Monetary Law (Oxford University Press, 6459), Sovereign Debt Management (OUP, 2014, co-edited), Cross-Border Bank Insolvency (OUP, 6455, edited) and Central Banking and Banking Regulation (LSE/FMG, 1996).
SUERF Policy Notes (SPNs) focus on current financial, monetary or economic issues, designed for policy makers and financial practitioners, authored by renowned experts. The views expressed are those of the author(s) and not necessarily those of the institution(s) the author(s) is/are affiliated with.
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