Here’s a question that occurred to almost nobody during the 2021-2022 inflation episode, even though its answer shapes most Australians’ economic lives.
When the Reserve Bank of Australia decided to raise interest rates repeatedly across 2022 and 2023 — the fastest cycle of rate increases in a generation, a decision that added hundreds of dollars a month to the mortgage payments of millions of households — who voted for this?
The answer is nobody. The Reserve Bank’s governor is appointed, not elected. The board that makes interest-rate decisions is appointed, not elected. The specific decisions about how high to raise rates, how quickly, how long to hold them, are made by a small group of economists and bankers whose names most Australians couldn’t produce, operating largely outside the democratic processes that theoretically shape other significant government decisions.
This is not a quirk or a scandal. It’s deliberate, well-considered, and — on most mainstream accounts — probably correct. Most advanced democracies have designed their central banks to be independent of direct political control, and the reasons for this design are genuinely good ones. But the design creates a specific tension in democratic theory that’s worth understanding clearly, because central banks now make some of the most consequential decisions governments make, and because the arguments for and against their independence run deeper than the usual partisan debates.
Why central banks were made independent
The case for central-bank independence was built primarily on a specific historical problem. In the 1970s, many advanced economies suffered from what came to be called stagflation — simultaneous high inflation and high unemployment. The conventional response of elected governments was to try to lower unemployment through looser monetary policy, which tended to produce more inflation, which eventually required painful corrective action.
The underlying dynamic, as economists diagnosed it, was a credibility problem. Governments facing elections have short time horizons. They benefit from lower unemployment before an election and pay the inflationary costs afterward. This produces a systematic temptation to loosen monetary policy for political reasons, even when the economic conditions don’t support it. Over repeated cycles, this produces higher average inflation without producing lower average unemployment — a worst-of-both-worlds outcome.
The response, gradually adopted across most advanced economies between the late 1980s and the early 2000s, was to take monetary policy out of the hands of elected politicians and give it to central banks with legal protection from political interference. The central banks were given specific inflation targets — usually around 2 per cent — and the autonomy to set interest rates as needed to meet them, regardless of what elected governments might have preferred.
The empirical case for this design is reasonably strong. Countries that adopted central-bank independence experienced, on average, lower inflation over subsequent decades without higher unemployment. A large body of research — much of it associated with the American economist Alberto Alesina — documented this pattern across dozens of countries and three decades. The basic finding held up well enough that central-bank independence became something close to economic orthodoxy, endorsed by economists across most of the political spectrum.
What the bank actually does
The Reserve Bank of Australia, like most independent central banks, makes decisions primarily through a small committee — the Reserve Bank Board, consisting of the Governor, the Deputy Governor, the Secretary to the Treasury (a government official, notably), and six external members appointed by the Treasurer. The Board meets eleven times a year to set the official cash rate, which flows through to the interest rates banks charge for mortgages, business loans, and other lending.
The cash rate decision is not merely technical. It shapes, among other things: the monthly payments on every variable-rate mortgage in the country; the returns on savings accounts; the exchange rate between the Australian dollar and other currencies; the affordability of business investment; the overall pace of economic activity; and the level of employment. A decision to raise rates by 0.25 percentage points typically reduces household disposable income for borrowers by hundreds of millions of dollars over subsequent months, while transferring some of those funds to savers and to bank profits.
These are, by any reasonable account, political decisions — in the sense that they have significant distributional effects on different groups in society. Borrowers lose when rates rise; savers gain. Workers in interest-sensitive industries lose when tightening slows the economy; workers in less-sensitive industries may be relatively protected. Homeowners face different effects depending on whether they’re on fixed or variable rates, and on their remaining loan balance. The decisions are made primarily on technical grounds — is inflation likely to meet target? — but the effects spread across society in ways that are anything but technical.
Under the doctrine of central-bank independence, these distributional effects are not considered by the Reserve Bank Board. The Board’s job is to meet its inflation target. The consequences for specific groups are someone else’s problem — presumably the elected government’s, through fiscal policy that redistributes the costs and benefits. This division of labour sounds clean on paper. In practice, the elected government’s capacity to redistribute is limited, and the distributional effects of monetary policy often fall where they land.
The counter-argument
Before accepting central-bank independence as a settled question, a serious counter-tradition is worth understanding.
The German-born American economist Friedrich Hayek, a noted defender of free markets on most issues, was actually sceptical of central-bank independence for a related but distinct reason. Hayek argued that central banks’ control of money was itself a form of government planning, and that the problems associated with it wouldn’t be cured by making the planners more technocratic rather than more democratic. His radical proposal, largely ignored in mainstream policy, was to denationalise money entirely — allow private currencies to compete, with markets sorting out which produced the best outcomes.
A more mainstream critique has come from economists and political theorists who accept that central banks need to exist but question whether their current independence is democratically legitimate. The American legal scholar Peter Conti-Brown has argued that the level of discretion granted to central banks exceeds what democratic theory can easily justify. The Reserve Bank Board is making decisions with enormous distributional consequences, based on judgements about empirical matters (is inflation likely to persist?) on which reasonable experts disagree. These judgements are being made without the usual democratic accountability mechanisms — debates in parliament, electoral contests, transparent deliberation by elected representatives — that most other consequential government decisions pass through.
A related concern, raised across the political spectrum, is that central-bank independence has grown at the same time that central banks’ responsibilities have expanded. The Reserve Bank in the 1970s was primarily concerned with interest-rate policy. The modern Reserve Bank, particularly since the 2008 financial crisis, has taken on roles in financial stability regulation, asset purchases to support markets, implicit management of exchange rates, and coordination with fiscal authorities in ways that previous generations wouldn’t have recognised. The expansion of responsibility hasn’t been accompanied by a commensurate expansion of democratic oversight.
And a specifically political critique, from economists including Stephanie Kelton (whose work was mentioned in the inflation article), argues that central-bank independence has allowed a specific economic framework — one that prioritises inflation control over other goals like full employment and equitable growth — to be treated as apolitical when it isn’t. Different central-bank strategies would produce different distributional outcomes. The choice among strategies is genuinely a political question that has been framed as technical.
The specific case of recent tightening
The 2022-2023 interest-rate tightening cycle illustrated these tensions sharply. The Reserve Bank Board, acting on its inflation mandate, raised rates aggressively. The resulting increase in mortgage costs fell heavily on households with recent mortgages — disproportionately younger households, who had bought homes at elevated prices during the earlier period of low rates. Older households with paid-off mortgages, and households renting in markets where landlords couldn’t easily pass through rate rises, were relatively protected.
This was not a distributional outcome the Reserve Bank Board chose or endorsed. It was a consequence of their inflation-targeting approach. Under the doctrine of independence, the distributional question is, strictly, not theirs to decide. The elected government could, in principle, have offset the effects through fiscal policy — cash transfers to mortgage-holders, changes to tax treatment, and so on — but in practice did relatively little of this. The Reserve Bank did its job; the distributional consequences accumulated; the political system didn’t, on the whole, compensate.
Defenders of independence would argue that this is a feature, not a bug. The system produced lower inflation, which was the goal. Anyone who dislikes the distributional consequences should take it up with elected governments, whose job it is to address such things. Critics would argue that this is precisely the problem — the Reserve Bank made consequential distributional decisions that the political system lacks the tools to offset, and the overall system therefore has weaker democratic legitimacy than it should.
Both positions have some merit. Neither is obviously correct.
What to hold
For an informed citizen, a few working principles seem defensible in thinking about this.
Central-bank independence is probably, on balance, a good institutional design for most of the last several decades. The alternative — direct political control of monetary policy — has a worse empirical track record than independence does. Criticisms of independence should grapple honestly with this.
The design has genuine costs, and those costs should be discussed honestly rather than concealed under technical language. Interest-rate decisions have massive distributional effects. These effects are made by unelected decision-makers. No institutional design is perfect, and central-bank independence has specific limits that are worth naming.
The expansion of central-bank responsibilities since 2008 is worth watching carefully. An institution designed for narrow inflation control may or may not be well-suited for the broader responsibilities that have accumulated around it. Whether the expansion has happened with appropriate democratic accountability is a legitimate question.
And, importantly, ordinary citizens should understand at least the basics of what their central bank does, because the decisions made by that small group of appointed officials affect their financial lives substantially. The normal democratic tools — voting, protesting, writing to representatives — don’t apply directly to these decisions. What does apply is informed public discourse about whether the system is working, and political pressure on elected representatives to either defend or reshape it.
The question that remains
The deepest tension in the central-bank question is one that democracy hasn’t fully resolved. Democratic legitimacy comes from accountability to voters. Some decisions — ones requiring long time horizons, technical judgement, and insulation from short-term political pressure — seem to work better when insulated from voter accountability. These two considerations pull in opposite directions. The current settlement — expert technocrats making consequential decisions under a mandate given by elected parliaments — is one answer. It isn’t the only possible answer, and it isn’t a stable or uncontested one.
Over the next several decades, the settlement will likely face more pressure as the effects of decisions made by independent central banks accumulate and become politically visible. How the tension is resolved, if it is, will matter for the kind of democracy that Australia and similar countries turn out to be.
The question to carry, especially the next time you hear an interest-rate decision announced:
The people making this decision — how did they get to be the ones deciding, and what would it take for them to be replaced if you thought they were getting it wrong?
Key research referenced: Alberto Alesina’s research on central-bank independence and inflation outcomes; Peter Conti-Brown, The Power and Independence of the Federal Reserve (2016); Friedrich Hayek, The Denationalisation of Money (1976); Stephanie Kelton and the Modern Monetary Theory tradition; general research on the history of central-bank independence.