Governor’s contribution marking the 25th anniversary of the ECB: the importance of central bank independence

05/30/2023 / Public apperances

On 1 June the European Central Bank celebrates the 25th anniversary of its founding, one of the milestones in the process of European integration. Slovenia became part of the Eurosystem when it joined the euro in 2007. Since then we have been playing our part in monetary policy decisions affecting 350 million people. In marking the anniversary I would like to take this opportunity to highlight a vital element in the lives of central banks: that is our independence in making monetary policy. I consider this to be one of the great institutional achievements of recent generations in the field of economic policy.  

Our priority within the Eurosystem is mantaining price stability, which is the primary objective of the common monetary policy. With the exception of the current period, when we are facing a specific situation caused by multiple shocks, over the last three decades or so we have lived in one of the most stable price environments of the modern age. In addition to shaping and implementing monetary policy, we undertake several other important tasks together, such as issuing euro banknotes and coins, ensuring the smooth execution of interbank, card and online payments, supervising commercial banks, and monitoring and mitigating risks in the financial system. This we can do better and more effectively together than we could alone, particularly in the smaller countries.

The concept of the ECB and the wider Eurosystem was profoundly influenced by the broader consensus in academic and professional circles that an independent central bank is essential to achieving low and stable inflation. This independence refers in particular to our mandate, which allows us to pursue monetary policy on the basis of our expert judgment. In addition to independence from political and other external influences, our independence also includes having sufficient financial resources of our own, and the availability of instruments and other conditions for performing our tasks. And not least, guaranteeing the central banking independence of the national central banks is one of the conditions for joining the euro.

Banka Slovenije has functioned as an independent institution since its establishment 32 years ago. A key role in the decision to establish an independent central bank was played by two broader global trends. The first was the political upheaval in eastern Europe after the fall of the Berlin Wall, the birth of new countries, and in this context Slovenia’s secession from the federal state of that time. This gave rise to the need to create new institutions or to reshape existing institutions for the new state. The second trend was the economic and political debate surrounding the effective conduct of monetary policy. Already in the first half of the twentieth century, the bad experiences of advanced economies with episodes of high inflation gave rise to the idea that monetary policy should be decided at an expert level, and not at a political level. The pioneering steps in implementation included the 1951 Treasury-Fed Accord in the US, and the principles of independence of the German central bank from 1957. These principles are the foundation of the Bundesbank's tradition, which was a key influence on the concept of the ECB and the broader Eurosystem.

The ongoing price instability and experience of the 1970s and 1980s encouraged a broader academic debate. Politicians also found that high inflation gave rise to political dissatisfaction, that a coherent expert framework was needed to reduce inflation, and that measures to reduce inflation were unpopular because of their short-term adverse effects. By the late 1980s the time was ripe for a broader approach to granting independence to central banks.

Although central banking has a long history, with some of the institutions in our region dating back centuries, central bank independence in making expert decisions is a relatively new concept, and the establishment of Banka Slovenije as the central bank of Slovenia coincided with the beginnings of this global trend.

Today central bank independence enjoys wide support as an institutional solution with considerable legal security. Amending the Treaty on the Functioning of the European Union, which speaks of the independence of the ECB, would for instance require a consensus. It also enjoys wide support from the profession and the general public, as evidenced by academic debate and various metrics of public opinion.

The data also shows this to be true: the era of independent central banks has been a time when price stability has mostly prevailed. Of course over 25 years we have faced a number of shocks, with the widest range of causes, which have unexpectedly pushed inflation too low or too high (one such shock is still manifesting itself) but our measures have succeeded in restoring it to the bounds set as optimal. This is important for sustainable economic growth and high employment. 

Central bank independence refers in particular to our mandate, which allows us to pursue monetary policy on the basis of our expert judgment.

Central bank independence is therefore one of the rare exceptions to the general rule of advanced democracies, that the majority of important actions are taken by the elected representatives of the people. Granting independence to technocratic institutions remains a rarity, strongly delimited by a clear mandate and an understanding of why there needs to be protection against short-term political objectives. We should therefore be fully committed to understanding our mandate, while at the same time being very prudent in how we manage our independence.

Whenever central bank independence is raised, our initial thoughts mainly go to preserving our independence from political influences, first on the personal level, through our integrity and in the awareness of our mandate, where we are experts, not political decision-makers. In Slovene we have a linguistic barrier to distinguishing between policy and politics, using the same word (politika) for both concepts. Political independence is also relevant at the institutional level. After a long period of unconventional monetary policy, with low and negative interest rates, abundant liquidity, and other innovative instruments and approaches, the reversal that we have undertaken on account of the fast and sharp rise in inflation is a huge change for stakeholders. This is also true of governments, who borrowed heavily during the pandemic and then during the energy crisis after the outbreak of the war in Ukraine, and whose debt servicing burden is being altered by rising interest rates.

The risks of fiscal dominance are also related to those of financial dominance. Recent months’ developments in the financial sector have shown that not everyone was ready for the reversal in monetary policy. This exposes us to the risk that excessive concern for stability on the financial markets could lead to monetary policy decisions that do not fully pursue our primary mandate of ensuring price stability. To avoid this, we have other instruments, separate from monetary policy, to address the excessive responses of the financial markets and the major liquidity challenges faced by banks. 

To me it seems important to mention one other aspect of our independence. In recent years, several global issues have arrived on the general political agenda (both policy and politics). I have in mind very important issues for all of us, such as the green agenda, gender equality, and energy. These are issues that will significantly enhance our lives, and so we can all be motivated and committed to helping find solutions. However we should bear in mind that in democratic countries the majority of major political decisions are taken by the elected representatives of the people, and that central banks are institutions that have been granted a clear but limited mandate. It is therefore vital that our intervention in the aforementioned areas remains within the bounds of our mandate, and free of any risks that could lead to our independence being undermined.

To conclude: the experiences of certain countries, Slovenia among them, from the time when central banks were not independent expert institutions, are quickly forgotten. The existence of an established institution with a clear mandate, and all the advantages that such an institution brings to us personally and to society as a whole, can, over time, be taken for granted. It is therefore vital that we act to strengthen our independence, by fulfilling our mandate in the key pillars of our work, that we are transparent in so doing, that we are also subject to the scrutiny of other institutions, and that we know how to clearly communicate what we are doing and why, and also what we are unable to address, again because of our mandate.

Boštjan Vasle