the evolution of central bank governance around the world
TRANSCRIPT
Trivia• World’s Oldest Surviving Central Bank – Riksbank (Sweden)
1668; Bank of England -1694.• Since 1989 (Fall of Soviet Union), 15 Central Banks were
created in Eastern Europe.• EU created European Central Bank.• In all these situations Central Bank law was revised or
rewritten.• Institutional objectives, practices and structures were
amended or created from scratch.
About this Article• Written by Christopher Crowe and Ellen E. Meade.• Published in Journal of Economic Perspectives – Fall 2007.• This article surveys and quantifies the trends in two areas of
central bank governance : Independence and Transparency• It tracks the progress of central banks in these two aspects in
the developing and developed countries for the past 10-15 years Inflation.
• Third aspect – Committee structure and decision making in Developed Countries.
• Main impetus widespread inflation during 1970’s.• Reasons:– Political pressure to boost the economy & reduce
unemployment.– Leads to high inflation in the long run.
• Solution: Delegate the responsibility of monetary policy to individuals who are highly averse to inflation and insulate them from the rest of government.
Central Bank Independence
Measurement – Cukierman, Webb, Neyapti (1992)
• Measured on four legal characteristics– Bank’s management is insulated from political
pressure by secure tenure and independent appointment.
– Government cannot participate in or overturn its policy decisions.
– Bank’s legal mandate specifies clearly defined objective for monetary policy.
– Financial Independence: Bank’s ability to restrict lending to the government.
Measurement – Cukierman, Webb, Neyapti (1992)
• Four legal characteristics pertaining to procedures for appointment or dismissal of the central bank governor, accounted for 20% of overall index.
• Three legal characteristics used for central bank’s policy formulation process, accounted for 15% of the overall index.
• A single characteristic used to judge the central banks’ policy objective accounted for 15% of the overall index.
• Eight characteristics to judge the limitations on central bank lending to the government, which accounted for 50% of the overall index.
Results
• Federal Reserve’s Score – 0.48 (low due to areas of policy formulation and the monetary policy)
• Federal Reserve Act directs the Fed to achieve both high employment and price stability conflicting objectives.
ECB & Riksbank
Implications• A key finding (Alesina and Summers – 1993) – statistically significant
association between greater independence and lower inflation for industrial countries.
• By reducing the hyperinflationary outliers and regrouping, inverse relationship was obvious in transition countries of central Europe.
• However this inverse relationship did not hold for industrial countries.• Another important aspect which the paper looked into was turnover of
Central bank’s Governor. • If high turnover , CB Governor’s office in term relative to the executive is
shortened susceptible to political interference. • Governments with low inflation did not tinker with central bank’s
governance and countries with higher inflation made their central bank more independent.
Implications - Downsides• Greater independence requirement for institutional and
personal accountability. (Eg: Bank of Italy – Antonio Fazio – Bank merger deal)
• Countries addressed this issue of accountability by limiting the mandate of the central bank – “Instrument Independence”
• U.K Government mandates Bank of England with inflation target of 2%.
• “Goal Independence” : Government gives the central bank a broad mandate that requires interpretation.
• Federal Reserve Act., tasks the U.S. Central bank with “maximum employment, stable prices and moderate long term interest rates.” – Fed must interpret and prioritize these goals.
Central Bank Transparency• Why?
– Communicating its intentions to the public ↓ Uncertainty– Though it influences short term interest rates but for monetary policy to
be effective, they must influence longer rates as well by signaling movements in future policy and anchoring inflation expectations (∏e).
• Measuring Central Bank Transparency– Political Transparency: Pertains to clarity of central banks legal mandate.– Economic Transparency: Refers to publication of economic data, models
and forecasts used by the central bank to arrive at its policy decisions.– Procedural Transparency: Communication of exclusive policy strategy as
well as information on the decision making process.– Policy Transparency: includes the timely announcement and explanation
of policy actions and some indication of likely future action.– Operational Transparency: Discussion of economic disturbances and policy
errors that are likely to affect the transmission of policy.
• Transparency Country Sample• Advanced economies (26)– Australia, Austria, Belgium, Canada, Denmark, Finland, France,
Germany,– Greece, Iceland, Ireland, Israel, Italy, Japan, Korea, Luxembourg,– Netherlands, New Zealand, Norway, Portugal, Singapore, Spain,
Sweden,– Switzerland, United Kingdom, United States
• Emerging market and developing economies (14)– Argentina, Brazil, China, Czech Republic, Hungary, India, Indonesia,
Mexico,– Poland, Russia, Slovakia, Slovenia, South Africa, Turkey
Central Bank Transparency
Central Bank TransparencyResearch Results
* European Central Bank remains much lower than the inflation targeting regimes. It reveals much lesser information.
Implications and Changes
Drawbacks to Transparency
• Ranking Central Banks based on transparency suggests that greater transparency is better and it can be achieved in an identical manner for each bank.
• Rational Behind this thought is that it will reduce uncertainty through better communication of the central bank’s goals.
• However transparency can lead to offsetting changes within the central bank’s decision making process.
• It can indeed increase the uncertainty rather than reduce it.
Organization of Central Bank Committees and Decision Making
• Virtually every central bank around the world replaced a single policymaker with a monetary policy committee.
• Governor of New Zealand Central bank is the lone policy maker setting the short term interest rates.
• Experiments suggest that a committee with five policy makers make better decisions than sole decision maker.
Concluding Remarks
• Discretionary policymaking in the hands of independent technocrats, rather than politicians.
• With greater credibility, Central Banks reassure the financial markets and reduce the economic cost of political crises.
• Improved communication through use of internet.