Banking on Reform: Political Parties and Central Bank Independence in the Industrial Democracies.

By William T. Bernhard. Ann Arbor: University of Michigan Press, 2002. 256p. $65.00.

This is a classical comparative politics treatment of a topic that has attracted a lot of attention in economics and relatively little attention in political science: central bank independence. Economists analyze what they take to be the politics of central bank independence by setting up reductionist three-player games that collapse the government, the central bank, and the private sector (or the people) into three “representative” agents. They then proceed to characterize the conditions under which central bank independence is a Good Thing. Central bank independence is treated as a deus ex machina: A government that is better off with an independent central bank can just simply declare its central bank independent and make its declaration stick.

To analyze the politics of central bank independence, we need to move away from such thin economic analysis. First, we need to relax the representative-agent assumptions and account for conflicts of interest within the government, within the central bank, and among the people, which includes attending to the political mechanisms by which such conflicts are resolved. Second, we need to address the roots of central bank independence by modeling the embeddedness of the central bank in the larger political system. This is the research program in political science, to which William Bernhard contributes, with the result that he can explain puzzles and patterns the economics literature can not.

We observe institutional change over time and institutional variation across countries. In the 1970s and 1980s, we find few independent central banks. Starting in the late eighties and throughout the 1990s, we see a wave of central bank reforms culminating in Europe with the establishment of an independent European central bank. Now, I suppose we could say, the early adopters—Germany, Switzerland, and the United States—intuitively got it right, and other policymakers followed once they read the central banking literature and saw the light. I do believe this is a case where the successful practice of the early adopters combined with an academic literature to influence reality, but there is more to the story. Certainly the research program in comparative politics is to prefer an explanation that relates institutional change over time, and the staggered pattern of reform across countries, to the political fundamentals of the countries in question.

Enter Bernhard. He argues that the choice of central bank independence, or of institutional arrangements that further independence, is a function of intraparty or intracoalitional conflicts. Such conflicts can threaten the ability of a party or party coalition to attain and remain in power. The act of delegating monetary policy to an independent central bank removes monetary policy from the political agenda so that it can no longer serve as a source of conflict. Moreover, parties and party coalitions are fraught with information asymmetries and monitoring problems. For example, backbench legislators are less well informed about government policy and suspicious of their government ministers. An independent central bank can serve as a credible information source separate from the government.

With a happy mix of case studies and regression analysis, Bernhard proceeds to tie together all the various puzzles and patterns as he provides empirical support for his hypothesis. Banking on Reform is comparative politics in action and at its best.

Inevitably, any truly comparative (systematic cross-country) exercise will run into a member of the audience who has deeper and more specialized knowledge about one of the countries included in the analysis and who will object, “This is not [fill in name of country].” I happen to know a lot about Germany, and I followed Bernhard's argument for all countries except for Germany. A book review is not the place to develop a full-blown alternative theory, so let me just pursue one line of thought.

One of the puzzles Bernhard describes is the independence enjoyed by the Bundesbank in the late 1970s and early 1980s when it followed a monetary policy that ran counter to the economic policy of the Social-Liberal Coalition. In the early 1980s, the Bundesbank pushed interest rates to their highest postwar levels. This was the time when German unemployment rates ratcheted up to their highest postwar levels from which they have since not recovered. The Social-Liberal Coalition fell apart over questions of monetary and economic policy. Certainly in the perception of the Social Democrats (and this is also Bernhard's view), the Bundesbank hurt the popularity of the Social-Liberal Coalition and contributed to its demise.

Here is what does not quite fit. Bernhard suggests that the Social-Liberal Coalition needed an independent central bank to reduce intracoalitional conflict and thus supported the Bundesbank. But the Bundesbank increased the conflict between the coalition partners: It drove them apart and the Free Democrats into the arms of the Christian Democrats. I interviewed leading Social Democrats in 1984, and it is clear to me that if the Social Democrats could have killed the Bundesbank, that is what they would have done. Leaders and backbenchers alike hated the Bundesbank. The problem was that they could not touch the Bundesbank because of the sacred status it enjoyed with the general public. In the late 1990s I was once again witness to conversations that now suggested to me that the Christian Democrats were just as unhappy with the extreme independence of the Bundesbank, which was seen as out of control. Much better to fold the Bundesbank into a European central bank and thereby get rid of it. Remember Chancellor Helmut Kohl's fierce determination to move forward with a European central bank? On this count he was backed by an all-party consensus that ran counter to economic models, implying that Germany would not benefit from a European monetary union and, counter to public opinion polls, suggesting that the German people were opposed to giving up their deutsche mark.

My argument is backed up by the work of Carlo Tognato, who recently analyzed the language of the Deutsche Bundesbank: How do Bundesbank representatives speak when they address the general public, on the one hand, and more specialized audiences, on the other? He found that public discourse on money and central banking in Germany is permeated with religious figures of speech; specialist discourse has no religious overtones. Vis-à-vis the general public, the Bundesbank pictures the deutsche mark as a religion, the Bundesbank as its high priest, and the Deutsches Volk as a select people. Germans are dropping their church memberships in droves, but their brains are still responding to religious cues. Tognato's dissertation pins down one root of Bundesbank independence—arguably the most powerful root: religion. As the idea for a European central bank was being formulated in the 1990s, scholars and policymakers pieced together an institution that in many respects resembles the Bundesbank. But it turns out that the religious underpinnings of Bundesbank independence did not travel nearly as well as the formal institution: The speeches of the European central bank are untouched by religious imagery. The European central bank is more independent on paper, but it is politically not as out of control as was the Bundesbank of old.