The Role and Independence of a Central Bank1
- Susana Almuina, Ian McCarthy, Gabriel Sensenbrenner, and Justin Zulu
- Published Date:
- December 1995
The word independence is rather imprecise and probably somewhat unfortunate as it may suggest concepts such as the self-sufficiency of monetary policy or the absence of control thereon, concepts unconnected with the anti-inflationary credibility that is supposed to be set in place.
The conventional literature on central bank independence reflects, in my view, two serious problems. First, it is difficult to pinpoint the concept of independence that is wished to be approximated. As total independence is illusory, assessment of the degree of independence requires that the model of autonomy deemed optimal be specified. And that is no mean task. A central bank might be thought to be all the more independent the greater its discretionary scope, subject to the minimal restrictions possible. But this view would be totally unrelated to the end purpose of making monetary policy more effective and facilitating the attainment of its final objectives. Clearly, from this standpoint, central banks entrusted with specific objectives in the task of achieving price stability may enjoy greater autonomy to pursue the appropriate monetary policy, although such objectives condition and delimitate the area of their independence. Thus, the defining terms of these objectives are more important than the fact that the central bank may have been attributed the formal capacity always to have the last word on monetary policy. Accordingly, unlike as occasionally claimed, independence and accountability appear as complementary rather than conflicting concepts.
Autonomy for the attainment of a specific goal must be accompanied by the appropriate control mechanisms. It is thus crucial that central bank action be taken in a setting understandable for the public and the markets and suitably transparent. Strictly speaking, all these matters constrain the central bank’s discretionary scope.
Second, there might be sizable discrepancies between the level of independence legally conferred on a central bank and its degree of autonomy in practice. The latter depends on a whole array of informal aspects, traditions, and unquantifiable factors that are relatively unlikely to be incorporated into legal provisions. Among the most difficult aspects to objectify are the personality of the central bank and government senior officials, their reputation and technical expertise, the informal relations between the central bank and the government, the financial institutions and markets, and the weight and influence of reports and public statements on economic policy issues. One crucial effect of the practical independence of central banks, though very difficult to test, is its capacity to influence the general economic policy stance. One of the unquantifiable elements of the independence of a central bank is the quality of its research department. Largely dependent on such departments are the central bank’s task of counseling the government, its influence on economic policy decisions and, ultimately, its ability to convey to society the importance of achieving the final objectives entrusted to it.
All these considerations should serve to restore some sense of proportion to the effect of the legal reforms aimed at making central banks independent. Independence is a necessary and positive process which tends to bolster the stabilizing capacity of monetary policy and to reduce any interference causing monetary and financial rectitude to slacken. An adequate legal and institutional form that provides the necessary degree of autonomy may indeed prove very useful. But that alone cannot resolve all the problems of anti-inflationary policy effectiveness, which are often rooted in the very structure of the economic system and in the habits of its economic agents. As stated, more than on its legal configuration, the autonomy of a central bank depends on its effective latitude for action. This is determined not just by legal provisions but also and mainly by a set of rules of conduct established tacitly or expressly by its relations with other agencies and decision-making bodies. In effect, a central bank, even though its formal independence is ensured, can only function relatively independently if there is sufficient social consensus as to the importance of preserving the goal of economic stability. It is misguided, therefore, to extend the view that central bank autonomy may act as a panacea for complex problems embedded in the culture of economic agents and in the structural flaws of the economy.
In this respect, it should be highlighted that an independent central bank can do little to ensure price stability if persistently unbalanced budgetary policies are retained or if labor market distortions mean wage setting continues to be systematically upward biased.
Central bank independence can adequately reinforce and complement a stability-geared overall economic policy strategy, and may also reduce the potential attendant costs. But it can never be a substitute for such a strategy and less so a factor in countering distortions stemming from other economic policy domains.
This statement was submitted after the St. Petersburg meetings.