Eric Monnet on the Democratic Legitimacy of Mighty Central Banks

‘Democratic money is bad money’. ‘Depoliticized money (…) is the ambition around the world’. This is how the influential economist Rüdiger Dornbusch summed up the macroeconomic zeitgeist that prevailed at the time the ECB was founded. The monetary authorities were supposed to maintain their independence simply by making their decisions as apolitically as possible and according to technical criteria only. In practice, this ideal of depoliticized central banks proved to be unrealistic. In the past three decades, especially after 2008, the tasks of central banks have expanded and their power has increased.

In his book ‘Balance of Power’, economic historian Eric Monnet describes that this development is by no means new: Over the last two hundred years, many central banks around the world have developed new instruments and strategies to react to unforeseen developments. Today, Monnet believes that monetary authorities have a duty to create more democratic participation and transparency.  In view of the worsening climate crisis and its macroeconomic consequences, central banks will also be faced with far-reaching decisions in the coming decades, which will push the ECB to the limits of its current mandate. He argues that in order to preserve the legitimacy of central bank independence and put central bankers at the service of wider democratic goals, it would be necessary to establish an exchange of perspectives and a critical review of monetary policy decisions by an institution outside the central bank. Would a “European Credit Council” under the supervision of the European Parliament be a suitable step towards a democratically legitimized, independent ECB?

We discussed these and other questions with the author via Zoom on July 11. You can rewatch the whole discussion below.

The author of the book emphasized the “trap of central banking,” where governments have placed extensive responsibilities on central banks, often viewing them as the primary solution to economic shocks. He noted the critical insurance function central banks provide during such shocks, which has become more pronounced due to the financialization of public debt. Monnet argued that although monetarists have historically discredited credit policy, central banks inevitably influence credit allocation, both intentionally and unintentionally.

Central bank mandates are often broad and vague, characterized by incomplete contracts. This vagueness necessitates that central banks develop new strategies in response to crises. In this context, Monnet stresses the need for strong accountability and deliberation between central banks and parliaments, proposing a redefinition of central bank independence. In democratic societies, a balance of power between legislative and executive branches is crucial. Monnet suggested the creation of a European Credit Council as a means to enhance accountability and legitimacy of the ECB. This council would facilitate a critical review of monetary policy decisions and foster a broader debate about central bank actions without pressuring the ECB directly. He also pointed out the new dilemma central banks face with inflation and climate change, where increasing interest rates to control inflation might hamper green investments, potentially exacerbating global warming and economic shocks.

Peter Bofinger, professor at the University of Würzburg, discussed the role of single central bank interventions in protecting states incapable of financial system reforms or green credit policy construction. He underscored the importance of central bank independence, cautioning against subjecting monetary policies to democratic control due to potential dangers to democracy. Bofinger outlined three new domains for central banks:

1. Ecological transition prices
2. Public debt management
3. Development of new forms of digital money

He argues that these new responsibilities necessitate additional measures beyond legal independence. While supporting the idea of a European Credit Council, he views it as a modest solution, suggesting that the council would only offer policy recommendations without making decisions, thus providing a platform for democratic control without undermining central bank independence. Bofinger also emphasized the importance of coordinating anti-inflation policies between central banks and other institutions, advocating for formal joint commitments between governments and central banks to manage economic trajectories more effectively.

Monnet further reflected on historical precedents, noting that similar credit councils existed in many European countries during the 1950s and 1960s to coordinate central bank policy with other economic policies. He believed that such coordination could significantly impact the effectiveness of monetary policies. Monnet argued that although the proposal for a European Credit Council might seem modest, if implemented effectively, it could fundamentally change the way monetary policy is perceived and executed. By enhancing coordination and democratic legitimacy, the council could ensure that central banks serve broader societal goals while maintaining their essential independence.