Author Topic: Autonomy of Central Bank: Rationale and Reality  (Read 33 times)

Offline Deanfbe

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Autonomy of Central Bank: Rationale and Reality
« on: February 07, 2019, 02:46:44 PM »
One of the primary tenets of accepted central banking thoughts has been the importance of keeping central banks politically independent. No other aspect of central banking has evoked more attention and discussion than the advocacy on making the central bank independent of any political authority. The concept of an independent central bank favors separating the power of creating money from the power of spending the money. Hence, the strongest argument for an independent central bank rests on the view that subjecting the central bank to more political pressure would impart an inflationary bias to the monetary policy. As argued by many observers, politicians in a democratic society are short-sighted, because they are driven by the need to win their next election and they are unlikely to focus on long-term objectives, such as promoting a stable price level. Instead, they will seek short-term solutions to problems, even if the short-term solutions have undesirable long-run effects. A politically-insulted central bank is more likely to be concerned with long-term objectives and thus be a defender of a sound currency and a stable price. Putting the central bank under the control of the government is considered dangerous, because the central bank can be used to facilitate financing large budget deficits and thus this help might lead to a more inflationary bias in the economy. An independent central bank is better able to resist this pressure from any government expenditure without raising taxes. An independent central bank, largely free from political pressure, is needed to ensure justice to those who lose from inflation.

Another argument for a central bank's independence is that the conduct of a monetary policy is too important to leave to politicians who may lack the expertise about making tough decisions on issues of great economic importance, such as reforming the banking system, or reducing the budget deficit. The crucial parameters like price level and exchange rate under no circumstances should be transferred to the political control variable. But removal of the monetary policy from the political sphere is itself a political act. There seems to be an even stronger case for an independent central bank in the developing countries, given the greater frequency and arbitrariness of political change coupled with politicization of finance. A recent research demonstrates that political instability causes instability at the central bank too, although the spillover effect varies from country to country. These are the questions which have not been addressed in the debate on the central bank's independence.

According to some experts, an autonomous central bank is necessary in Bangladesh to conduct a sound monetary policy and exercise utmost prudence in such matters such as licensing new banks and the use of directed credit. Experience with government intervention in these matters in Bangladesh underlines the importance of establishing an autonomous central bank in our country. The boards of directors of state-owned banks and financial institutions need to be constituted with people having sound knowledge about the national economy and the financial sector. However, the Bangladesh Bank has not been given any authority to appoint independent directors to private banks under the recently-amended Banking Companies Act 2013. The Bangladesh Bank can remove MDs of state-owned banks but has no such authority, when it comes to the boards of directors. A strict application of the criteria set by the Bangladesh Bank for selection of qualified persons with good reputation and right professional profile for boards of directors in state-run banks is needed so that the directors in the state-run banks can perform up to the desired level of competence to keep the banking system on the right path.

However, the central bank must show an objective and independent attitude to various sectors and interest in the economy and it should earn a reputation for impartiality. The personality, prestige and the competence of the central bank management in any country can go a long way in persuading the banks and the government to formulate and implement an appropriate monetary policy for a country.

THE CASE AGAINST INDEPENDENCE OF CENTRAL BANK: Proponents of the government's control of the central bank argue that it is undemocratic to have a monetary policy (which affects everyone in the economy) formulated by an elite group responsible to none. The people hold the president or parliament responsible for the economic well-being of the country, yet they lack control over the government agency, the central bank that may well be the most important factor in determining the health of the economy. The monetary policy involves difficult decisions from a long-term perspective. The public hold the government responsible for the economic conditions that result from all the policies followed by the government. Hence the government should have control over the monetary policy. It seems to be undemocratic to say that elected officials, in a parliamentary democracy, should not be trusted to judge the monetary policy. Monetary and fiscal policies should be integrated and   adequate integration cannot be achieved merely by a process of informal consultation. Rather it requires that the central bank becomes part of the administration. Giving the government control over the central bank does not necessarily call for weakening its influence, rather strengthening it. If it was a part of the administration, the central bank advice could then be better heeded by the government. However, there is yet no consensus on whether an independent central bank is a good idea, although the public support for independence of a central bank seems to have been growing in different countries of the world.

The arguments for and against independence of a central bank may give the wrong impression that the choice is between two irreconcilable extremes. But this is not so. Even if the central bank was to lose its formal independence and become a part of the government administration, there could still be an attempt to keep it out of partisan politics.

Offline rayhanul.bba

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Re: Autonomy of Central Bank: Rationale and Reality
« Reply #1 on: March 28, 2019, 12:49:43 AM »
Informative post. Thanks for sharing.
Md. Rayhanul Islam
Senior Lecturer
Department of Real Estate
Facuty of Business & Entrepreneurship
Daffodil International University