European Central Bank president ( ECB ) Christine Lagarde has outlined three conditions to safeguard central bank independence.

In almost half the central banks located in countries that account for 75% of world GDP, she says de facto independence has deteriorated over the past decade.

Speaking at a conference of governors from French-speaking jurisdictions in Phnom Penh, Lagarde notes recent attacks on Jerome Powell, the US Federal Reserve Board chairman whose term expired in May.

“When the chair of the Federal Reserve publicly defended the institution’s independence, the ability to contain political pressures was thanks to the public support built up over the years through the Fed’s independent decision-making,” she says. “Voices from across the political spectrum had also underscored this independence.

“The matter is not settled, but we can clearly see the mechanism at play – where credibility exists, defending independence does not fall on the central bank’s shoulders alone. Instead, it is upheld by all those who have witnessed its value.”

According to Lagarde, treaties give the ECB independence but crises give it “the authority it previously lacked to exercise that independence effectively. But that is not the whole story. All of this was built in an environment that was still favourable, one where globalization absorbed many of the shocks.

Less favourable environment

“Today, this environment is undergoing a transformation. And the framework in which we operate has become more demanding.”

To safeguard central bank independence, Lagarde highlights the need for “clarity of the mandate, as understood by the central bank itself.

“Price stability must remain the primary objective, and it must be defended even if there is a real, immediate cost,” she says.

The Eurosystem supports general EU economic policies if “they do not harm this primary objective [which] protects the central bank from outside pressure and allows it to commit to secondary objectives, but never at the expense of the first.

“When a central bank is seen to turn this hierarchy on its head, its independence suffers as a result.”

The ECB president identifies "direct communication with citizens” as the second condition.

“The anchoring of inflation expectations depends on households being convinced that the central bank will do what it says.

“This conviction is built less by words than by accumulated experience – the sense that commitments, once made, are consistently kept.”

This gains legitimacy “through transparent decision-making methods and accountability to elected institutions,” she says. “It is in this space that credibility is earned – and also where it can be lost most quickly, when decisions and words no longer align.”

'Room for manoeuvre'

Lagarde also stresses the need to preserve “the room for manoeuvre" of monetary policy.

“That room depends first and foremost on fiscal responsibility – the legal frameworks cannot safeguard central bank independence when fiscal trajectories become unsustainable,” she says, adding that it also depends on the resilience of the financial system.

When fragility in parts of the system makes interest rate changes potentially destabilizing, the room for manoeuvre is “curtailed” and financial stability considerations “risk overshadowing price stability”.

Six years after establishing the Banque de France in 1800, Napoleon Bonaparte “tightened his grip on the central bank, and gradually took back the independence he had granted,” Lagarde notes.

“It is precisely this temptation that the period ahead is likely to sharpen. Over the two centuries that separate us from that period, a remarkable institutional response has emerged – one that must, however, be protected and cultivated.

“In a world where conditions are getting harder, the challenge is no longer to simply maintain legal independence, but above all to maintain the credibility that is needed to exercise it.

“And the lesson of history is clear – it takes time to build trust, but only an instant to lose it.

“For money rests on a promise – that its value will be preserved over time. This promise depends on the trust that citizens place in the institutions charged with safeguarding it.”

Jointly hosted the National Bank of Cambodia and the Banque de France, the four-day conference opened on May 28 with 26 central banks taking part.