Banking on Reform: Political Parties and Central Bank Independence in the Industrial Democracies

Chapter 7. Party System Change and Central Bank Reform in Italy and Britain

CHAPTER 7 Party System Change and Central Bank Reform in Italy and Britain Throughout the industrial democracies, economic internationalization has created potential conflicts over economic and monetary policy within the leading governing parties. Increased levels of economic openness have altered the policy preferences of key constituent groups, diversifying the demands made on these parties. At the same time, the ability of parties in office to deliver promised outcomes has also declined. These developments threaten the traditional parties) ability to attain and retain office. Consequently, many parties have modified their electoral and policy strategies in order to reshape their electoral coalitions and maintain electoral viability. Central bank reform is one component of this change in party strategy. A more independent central bank can help prevent intraparty conflicts over monetary policy and enhance the government's policy effectiveness) helping parties meet the political challenges of economic internationalization. In this chapter) I illustrate this argument by discussing central bank reform in Italy and Britain. In both countries, the economic and political developments of the 1970s and 1980s created the potential for conflict within the governing parties. In Italy) divisions over economic policy within the ruling coalition and changes in the political strategy of the Communists endangered the dominant position of the Christian Democratic Party in the late 1970s. In Britain) both the Labour and Conservative parties suffered from intraparty conflicts brought about by economic change in the 1970s and 1980s. As these internal divisions threatened the viability of the major parties) pressure to grant the central bank more independence increased in both countries . In Italy) the Christian Democrats initiated the "divorce" of the Bank of Italy in 1981) freeing it from some of its obligations to finance the government 's budget deficit. Italy)s politicians continued to grant the bank increased 125 126 Banking on Reform authority for monetary policy through the 1980s and 1990s, even as the Italian party system crumbled. In Britain, central bank reform was delayed. An independent central bank would have seemed to complement the Thatcher government 's monetarist policies in the early 1980s. Yet the Conservative government resisted demands for an independent Bank of England because, in part, Britain's majoritarian institutions protected the cabinet's position in office. Not until the election of a Labour government in 1997 was the central bank granted control over policy instruments. In both countries, central bank independence was part of a larger process of policy and institutional reform-reforms designed to maintain and extend the social coalitions underpinning the main parties and protect their security in office. Around the time of the divorce, the Christian Democrats proposed reforms in a number of other issue areas, including regional, fiscal, and industrial policy. In Britain, the Labour government held referenda on the establishment of regional parliaments and studied electoral reform. The coincidence of monetary reform and other political reform supports the argument that changes to the party system conditioned the choice of central bank institutions in the 1990s. This chapter examines the Italian and British cases in more detail. The first section discusses political and economic developments in Italy leading up to the divorce. The second section focuses on Britain and debates over central bank reform in the 1990s. Central Bank Reform in Italy Since World War II, the Christian Democratic Party played a predominant role in the Italian party system. But the economic shocks of the 1970s exposed deep divisions within the party and the ruling coalition, leaving the Christian Democrats politically vulnerable. The Christian Democrats responded with a series of reforms, including the divorce of the Bank of Italy, designed to revitalize the party's fortunes. The reforms, however, were not enough to rescue the party. This section first discusses the position of the Christian Democratic Party in the Italian political system. It then examines the political response to the economic shocks ofthe 1970s, which left the Christian Democrats in a precarious position . Finally, it investigates the divorce ofthe Bank of Italy and its consequences. The Dominant Christian Democrats In the postwar period, the Christian Democratic Party dominated Italian politics . Although the party never commanded a legislative majority, it consistently Party System Change and Central Bank Reform in Italy and Britain 127 won the highest number of votes and seats in the system. And although cabinets changed with almost alarming frequency, Christian Democrats always held the most important ministries. As the major party in government, the Christian Democrats benefited...