Is the independence of central banks in peril?

Is the degree of independence of central banks declining? This rather academic-sounding question is indeed a significant one, at least from a capital market perspective. In the extreme case of a total loss of independence, a portfolio should be exposed as little as possible to the respective monetary system (money market, government bonds, currency). Instead, investors should give preference to asset classes such as gold, Bitcoin, equities, corporate bonds, and government bonds with a high degree of credibility in terms of price stability. Please note: investing in securities involves both opportunities and risks.

Turkey as a case study: political influence and inflation dynamics

The prices of Turkish government bonds denominated in the local currency, the Turkish lira, have increased by 57% since the beginning of 2021 (source: ICE BofA). At first glance, this seems positive. However, high price increases in the economy have caused purchasing power to fall by 85% and put pressure on the currency (which has depreciated by about 81% against the euro). Bond yields have averaged 23% compared with average inflation of 49%. The inflation-adjusted (real) yield was therefore abundantly negative. In euro terms, the value of Turkish bonds did not rise, but instead fell by just under 71%. In contrast to bonds, Turkish equities (MSCI Turkey) rose significantly (by an annual average of 56%). The inflation-adjusted return on equities was therefore clearly positive (annual average: about 7%). This means that for investors in Turkey, equities provided good protection against inflation. Equity investors from the Eurozone also recorded gains (56% per year in local currency vs. 42% per year of currency depreciation).

What was the main reason for the high inflation in Turkey? Probably politics. President Recep Tayyip Erdoğan has long held the view that high interest rates cause inflation. As a result of this stance, key-lending rates were cut even though inflation was already on the rise.

Monthly development of the EUR/TRY exchange rate from September 2021 to September 2025 (in TRY)

Sources: ECB, Statista, data as of September 2025

Historical perspective: from the gold standard to inflation management

The idea that central banks should be independent is relatively recent. The first central banks, such as the Swedish Riksbank (founded in 1668), the Bank of England (1694), and the Banque de France (1800), were often established as private companies that were granted a monopoly on issuing banknotes by the state. Their main function was to finance government spending, especially in times of war. An independent monetary policy was not envisaged. In the 19^th century, the gold standard dominated.

Bretton Woods

After WWII, the Bretton Woods system was introduced, which provided for fixed exchange rates and gave central banks only limited monetary policy autonomy. The system was based on fixed exchange rates, with the US dollar pegged to gold at USD 35 per ounce. In 1971, President Nixon announced the end of the US dollar's convertibility into gold. In 1973, most countries abandoned fixed exchange rates.

Floating exchange rates

This was followed by a transition to floating exchange rates: exchange rates were determined by supply and demand on the foreign exchange market. Central banks would occasionally intervene to stabilise the currency. However, the stagflation of the 1970s (high inflation in combination with stagnant growth) illustrated very well that the monetary policy should not be politically motivated in a system of floating exchange rates. Otherwise, there was a risk of high inflation and currency deprecation. As a result, the monetary policy was increasingly used as an instrument to combat inflation. Central banks such as the German Bundesbank and later the Fed and the Reserve Bank of New Zealand were given more autonomy. From the 1990s onwards, many central banks adopted inflation targets as their monetary policy model. In 1990, the Reserve Bank of New Zealand was the first to have a legally binding inflation target. With the Reserve Bank Act 1989, which came into effect on 1 February 1990, the RBNZ became the first central bank in the world to enshrine an inflation target as its primary monetary policy objective in law. The bank was granted operational independence: it could take monetary policy decisions without direct political influence.

Counterpressure

The post-Bretton Woods era was characterised by increasing market orientation rather than state control, globalisation of the financial markets, and independent monetary policy. However, two developments, one slow and one fast, have been creating a certain amount of counterpressure. Firstly, high and rising government debt and, secondly, the unorthodox policies of the new US administration.

High interest payments

According to the OECD, interest payments on government debt across the OECD area will increase to 2.7% of nominal gross domestic product (GDP) this year. This figure was last reached in 2000. The difference to that time, however, was that the government budget excluding interest payments (the primary balance) amounted to 1.8% of GDP at that time. The estimate for this year is minus 1.6%. This results in an estimated overall state budget deficit of 4.3% for this year (2.7% interest payments plus 1.6% primary deficit). As most countries have so far shown little effort to reduce their budget deficits (see, for example, the USA and France) and interest payments are likely to continue to rise, budget deficits are likely to remain high for the foreseeable future.

Government debt in the most important industrialised and emerging countries in 2024 relative to the GDP