The Role and Independence of a Central Bank
- Susana Almuina, Ian McCarthy, Gabriel Sensenbrenner, and Justin Zulu
- Published Date:
- December 1995
The background paper on the role and independence of a central bank is designed to elicit a general exchange of views. I would like, however, to briefly draw your attention to some more specific considerations.
The Baltic countries, Russia, and other countries of the former Soviet Union are grappling with daunting macroeconomic problems. Major structural adjustments are required, reflecting both the transition to market economies and the external shocks that the breakup has produced. In very difficult circumstances valiant efforts are being made to adjust. However, the temptation to find quick solutions, including financing imbalances via the printing press, would be a move in the wrong direction. Going this route when the production and distribution systems are facing major, if temporary, distortions would only exacerbate inflationary pressures.
The precise role and the degree of independence that should exist for each of the new central banks of the Baltic countries, Russia, and other countries of the former Soviet Union are, however, a matter of debate. Some observers have argued that the situation facing these banks is sui generis and that the roles set for central banks in market economies and the degree of independence which they possess are inappropriate for these countries in the existing circumstances. It is argued that, in the present transitional stage, the financial systems and central banks are themselves experiencing operating strains that would not normally be faced. Consequently, these conditions have to be taken into account in setting the immediate role that the central banks can play. This would also include the degree of de facto and de jure independence that the banks should and will exercise.
It should, however, be remembered that, while the cooperating central banks are now facing a more stable environment, many of them have in their time faced similar problems; namely, price pressures from structural changes and insufficient fiscal discipline. In that sense, the experience of the new central banks is hardly unique. We believe, therefore, that there are common factors and good grounds for arguing that the basic role of a central bank and the degree of independence that it should exercise are not qualitatively different for the Baltic countries, Russia, and other countries of the former Soviet Union. While there are structural differences between the two situations, the transitional adjustments need not and should not necessarily conflict with the longer-term objectives.
First, given the fiscal imbalances, the extent to which the central banks alone can target price stability is limited. Until there is fiscal discipline and stability the role of the central banks is likely to be limited to leaning against the wind and asserting its point of view, and its degree of independence is likely to be limited. Second, the type of instruments of monetary control that the central banks can effectively use in the present circumstances may well be different. In the absence of efficiently functioning financial markets, the central banks may need to rely initially on direct controls, such as credit limits, but these would have to be designed in such a way that they can evolve into market-based instruments. Third, the fragile state of the financial systems means that the central banks will necessarily have a more direct role in speeding the development of the financial system. This would hardly be inconsistent with the longer-term objective that the central bank should ensure the soundness of the financial system, especially in the context of moving toward a market-based system.
In the last analysis, the central banks of the Baltic countries, Russia, and other countries of the former Soviet Union will have to fight for and earn independence. This will involve convincing their Governments and subsequently the public at large of the benefits of low inflation and the benefits of independence; one of the ways to achieve this is by building a comparative advantage in formulating and implementing monetary policy. In this context, the development of information systems and the establishment of analytical and research capabilities as a matter of priority are of central importance. Only by recruiting and retaining staff with good skills and high professional integrity can these objectives be more effectively realized.
Since the 1980s, there has been a convergence in the thinking with respect to two ideas about central banking; first, that a central bank’s main mission should be to pursue and maintain price stability as the best strategy for sustainable economic growth; and second, that to achieve its main objective, a central bank should be independent from political influences. This conclusion is, in effect, the result of accumulated experience. The message is very important for all market-based economies, because the possibility of renewed inflation is always a present danger. The paper that we have prepared presents various practical attempts by the membership of the IMF to address these two issues. The sample of existing arrangements may seem generic and familiar, but it is the practices and experiences which are the real substance of the exchange of views today.