The hidden revolution

PRIESTS OF PROSPERITY

How Central Bankers Transformed the Postcommunist World

Juliet Johnson

Speaking Tiger

284 pages; Rs 895

In the popular discourse, the United States Federal Reserve is often held up as a shining example of a truly independent central bank. The reality, though, is far from it. 

In a widely cited paper, economists N Nergiz Dinçer and Barry Eichengreen find that the Fed, a supposed beacon of independence, is one of the least independent central banks in the world. Surprisingly, the most independent ones are those of the Kyrgyz Republic, Latvia, Hungary, Armenia, Bosnia and Herzegovina. 

How did this come about? How did some of these erstwhile communist nations end up creating the most independent central banks in the world? 

In a new book titled Priests of Prosperity, Juliet Johnson, professor of political science at McGill University, attempts to explore this by examining the evolution of central banks in Hungary, the Czech Republic, Slovakia, Russia, and Kyrgyzstan. 

Drawing on over 160 interviews with central bankers, international assistance providers, policymakers, and private-sector finance professionals, Johnson argues that the collapse of the Soviet Union exposed the limitations of central banking in communist countries. Used to operating in a command-and-control economy, central banks in these countries were ill-prepared to deal with the functioning of a market economy. In the open era, they needed a new operating manual. 

Fortunately for them, a consensus on the role of central banks had emerged by then in the bastions of monetary economics. At the core of the consensus was a notion that price stability is the primary objective of monetary policy. Other objectives such as financial sector supervision were neglected owing to lack of consensus among economists. 

Ms Johnson argues that these ideas, which formed the bedrock of the western central banking consensus, permeated through eastern Europe with relative ease in the aftermath of the collapse of the Soviet Union. These spread in part by learning (through various learning programmes conducted by the International Monetary Fund (IMF), competition (between countries that hoped this would attract foreign capital), coercion (external pressure), and socialisation. 

Knowledge was transferred with relative ease as many national central bankers served as their country’s IMF representatives. They were routinely exposed to the latest academic research. Interacting regularly, away from the public glare, central bankers in these countries were able to hold detailed discussions with western central bankers and to draw on their contemporaries for advice.

The institutions at the forefront of the transformation were notably European — the Bank for International Settlements (BIS), the IMF, and the European Central Bank. The latter was extremely influential, particularly over those countries that wanted to join the European Union. Aided by western counterparts, central bankers in these countries managed to convince the political class to pass legislation, enshrining the independence of central banks. 

It is truly remarkable that such a transformation was able to take place during one of the most tumultuous periods in the post-war Soviet Union. Perhaps, as Ms Johnson puts it, “a moment of consensus met a window of opportunity”. 

But this legally enshrined independence had its downside. It often made central bankers political scapegoats during times of uncertainty. Politicians were quick to attack central banks, attempting to undercut their legitimacy and credibility.

One would have thought that the crisis of 2008, which exposed the limitations of the consensus, would have pushed these central bankers to openly challenge the hegemony of the western institutions. 

But as Ms Johnson points out, these bankers expressed the same kind of concerns as their western counterparts. In fact, they defended their principles and practices in the same language. And, despite mounting criticism of the hallowed objective of price stability, they continued to pursue inflation targeting regimes, though in some administrations banking supervision did gain prominence. Perhaps the desire to be part of the Euro or international legitimacy played a role. 

Two countries — Hungary and Russia —  stood out in their approach. Alleging that the international financial order was bankrupt, these countries pursued a new approach. Their strategy, as Ms Johnson calls it, financial nationalism, rests on using financial levers to promote the nation, reducing external influence and constraints imposed on domestic politicians to take economic decisions, especially during periods of turmoil. 

Although the book is a masterly account of the transformation, it could have benefitted from a detailed exploration of how these central bankers actually performed during the intermittent years. Did their independence help usher in a period of price stability? Were these countries better off under the new architecture? It may also have been worth exploring whether the complementary reforms needed for the smooth functioning of monetary policy — a well-functioning bond market, currency markets, judiciary and so on — were implemented by these nations.  

That said, the book is a testament to the durability of ideas propagated by Western institutions, which continue to hold sway over the profession, despite mounting evidence pointing to their pernicious effects.