The independence of central banks stands as one of the most consequential institutional innovations in modern economic governance. Born from painful lessons of inflation and political manipulation, central bank autonomy has, over the more recent decades, become a cornerstone of economic stability across developed democracies. Yet this carefully constructed framework now faces questions and pressures that reflect evolving debates about the proper relationship between elected officials and independent institutions.

The Case for Independence

The argument for central bank independence emerged from hard experience rather than abstract theory. Throughout history, governments repeatedly succumbed to the temptation of using monetary policy for short-term political gain, often with severe consequences. Politicians facing re-election found it expedient to stimulate the economy through loose monetary policy, even when such actions fuelled inflation and undermined long-term stability as money lost its value.

The 1970s proved particularly instructive. Inflation throughout much of the Western world rose to very high levels. This period saw gold prices surge as investors sought protection from currency debasement, a pattern that repeats whenever central bank credibility comes into question.

Germany provided a contrasting model. The Bundesbank, established with strong independence following the hyperinflation trauma of the Weimar Republic, maintained better price stability even as other nations struggled. This relative success directly influenced the design of the European Central Bank (ECB), established in 1998 with independence enshrined in the Maastricht Treaty of 1992. The Bank of England’s (BOE) transformation came in 1997. The Labour government granted it operational independence to set interest rates, ending long periods of Treasury control.

The Economic Advantages

The benefits of central bank independence rest on a simple but powerful principle. Independent central banks can make decisions based on long-term economic welfare rather than electoral calculations. Central bankers do not need to face electorates. Therefore, they become free to set monetary policy as appropriate rather than what is popular. This insulation from political pressure enhances credibility. When businesses and workers believe prices will remain stable, they adjust their behaviour accordingly. Wage negotiations become less contentious, businesses plan investments with greater confidence, and the economy functions more efficiently.

The evidence is clear. Countries with more independent central banks have historically experienced lower average inflation cementing long term economic success. The Federal Reserve’s (Fed) performance under Chairman Paul Volcker in the early 1980s illustrates this perfectly—the Fed’s willingness to inflict short-term economic pain broke the back of inflation and established credibility that served the American economy well for decades.

Recent Debates Over Central Bank Independence

The relationship between political leadership and the Fed has become a topic of renewed discussion recently. President Donald Trump, who began his second term in January 2025, has taken a more vocal approach than his predecessors. He has openly criticized Fed Chairman Jerome Powell’s interest rate decisions, arguing that rates were too high. Recently the US Department of Justice served subpoenas threatening Mr. Powell with criminal prosecution concerning his testimony to Congress last year about the Fed’s renovation of its headquarters. Whatever the merits of the case, this development further unnerved investors.

The concern among economists and investors is whether we might end up into more direct attempts to influence policy decisions. Financial markets tend to react negatively to uncertainty about the policy framework. Sustained questions about Fed autonomy could affect investor confidence and raise medium to long term borrowing costs.

Unsurprisingly, concerns about monetary policy credibility have contributed to increased investor interest in alternative stores of value. Gold has seen renewed attention as a traditional hedge. For some, cryptocurrencies like Bitcoin could act as a modern alternative since it is considered as “digital gold“.

Lessons from Ancient History

Episodes of money debasement are neither new nor recent. The Roman denarius provides a classic example from antiquity. Originally struck with around 95% pure silver, the coin’s silver content was progressively reduced by emperors facing military expenses and economic pressures. By the 3rd century AD, the denarius had been devalued to contain only about 5% silver. This massive debasement caused severe inflation throughout the empire, with prices skyrocketing and the currency losing credibility as people resorted to barter or demanded older, more valuable coins. The ensuing economic chaos forced Emperor Constantine to introduce the gold solidus in 312 AD. The solidus, which had a reliably consistent weight, restored confidence in the currency and became the standard for the Byzantine and European economies for many many years.

Looking Ahead

Central bank independence represents a triumph of institutional design over political convenience. The Fed, ECB, BOE and others, have used their autonomy to deliver price stability and buttress economic resilience.

The current debates about the proper boundaries between political leadership and central bank autonomy reflect important questions about democratic governance. These discussions can be valuable if they strengthen our understanding of why institutional independence matters. The challenge is maintaining the credibility that allows central banks to focus on long-term economic stability while remaining appropriately accountable.

The history of money and central banking offers a clear lesson. The benefits of sound money and central bank independence are too important to risk. Even as we acknowledge the legitimacy of ongoing dialogue, we must remember that losing central bank credibility is far easier than rebuilding it.

Written by

Josef Portelli, CFA

Managing Director – ReAPS Asset Management Ltd

The information contained in this article represents the opinion of the contributor and is solely provided for information purposes. It is not to be interpreted as investment advice, or to be used or considered as an offer, or a solicitation to sell/buy or subscribe for any financial instruments nor to constitute any advice or recommendation with respect to such financial instruments. This article was issued by ReAPS Asset Management Limited, a subsidiary of APS Bank plc. ReAPS Asset Management Limited (C77747) with registered address at APS Centre, Tower Street, Birkirkara BKR 4012 is regulated by the Malta Financial Services Authority as a UCITS Management Company and to carry out Investment Services activities under the Investment Services Act 1994 and is registered as an Investment Manager under the Retirement Pensions Act.