By Gavyn Davies
The macroeconomic debate is now buzzing about “political dominance” over the central banks, under which elected politicians force central bankers to take actions they would not choose to take, if left to their own devices . This is clearly what is happening in Japan, where the incoming Shinzo Abe government is not only imposing a new inflation target on the Bank of Japan (which is legitimate), but is changing the leadership of the central bank to ensure that the BoJ adopts policies compliant with the fiscal regime. This is not just political dominance, it is fiscal dominance, where monetary policy is subordinated to the decisions of those who set budgetary policy.
There have also been some early signs of political or fiscal dominance emerging elsewhere, notably in the use of the ECB balance sheet to finance cross-border financial support operations in the eurozone, and the “coupon raid” conducted by the UK Treasury on the Bank of England. Many investors have concluded that there is now an inevitable trend in place that will overthrow central bank independence throughout the developed world, allowing politicians to expand fiscal policy, while simultaneously inflating away the burden of public debt.