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Ownership, control of central banks

By Alexander Maune

Central banks increasingly see themselves as active supporters of political programmes, and thus as financiers of the state, rather than as monetary guardians.  — Ronal-Peter Stoeferle and Mark J. Valek.

According to Amadeo (2018), a central bank is an independent national authority that conducts monetary policy, regulates banks, and provides financial services as well as economic research. Its goals are to stabilise the nation’s currency, keep unemployment low, and prevent inflation.

Most central banks are governed by a board consisting of its member banks. The country’s chief elected official appoints the director. The national legislative body approves him or her. That keeps the central bank aligned with the nation’s long-term policy goals.

At the same time, it is free of political influence in its day-to-day operations. In this respect, Cukierman and Webb (2011) wrote a must-read article entitled: Political Influence on the Central Bank: International evidence.

It is critical to unveil the ownership structure of central banks to know whether they serve the interest of the nation or a few individuals.

To Hille (2017), central banks should be independent of the interest of a political party, individual citizen, individual corporations or a tyrant or despot. To avoid a central bank from being biased towards the interest of individual or corporate owners, the bank should not be privately owned and should be run independently from the rest of the elected government.

Central banks then require that the banker has a secure enough job that any party or ruler could not threaten their termination to get their politically desired outcome.  The appointment process of directors and governors must not be left to political parties. There must be established institutional processes to that effect so that competent people are elected to those positions. Ownership and control of central banks are very critical. Central bank systems must not be secretly owned and covertly controlled by powerful local and foreign banking interests as claimed by Mullins (1983) and Kah (1991).

This, Flaherty (2001) argues, is unhealthy as these players will manipulate the country’s monetary policies to further their global political goals and interests at the expense of the host country and local people.

It must be noted that there is no standard ownership structure of central banks as these differ from country to country.

As much as it is good practice to promote the independence of central banks, it is also critical to have well-established institutions; yes central banks are independent, though indirectly or directly controlled by treasury argues Flaherty (2001).

So, well-established government institutions are very critical. The actions of the government must be complementary or creating an enabling environment to facilitate growth or inspire growth-oriented manoeuvres. But really why the independence of central banks important?

Central bank independence

In 1985 Kenneth Rogoff argued, in what was later called the Rogoff’s conservative theory of CBI, that society can sometimes make itself better off by appointing a central banker who does not share the social objective function, but instead places “too large” a weight on inflation-rate stabilisation relative to employment stabilisation. In this case the governor places a greater weight on the loss from inflation than the government does (Herrendorf and Lockwood, 1996).

Rogoff (1985) suggests the desirability of having a CB`s operations financed independently from government`s seignorage revenues. Rogoff’s formulation reflects both a form of goal independence and instrument independence.

Because the central bank cares more about achieving its inflation goal, the marginal cost of inflation is higher for the central bank than it would be for the government (Walsh, 2005). In his conclusion, Rogoff (1985) states that, “it can be entirely rational for society to structure its central bank in such a way that the monetary authorities have an objective function very different from the social welfare function.”

Central bank independence is one of the means by which a government can choose the strength of its commitment to price stability. Price stability is also necessary, although far from sufficient, for developing a local capital market where both government and businesses can borrow more conveniently and cheaply in the long run.

Assuring price stability, therefore, usually requires ensuring that the central bank is not forced to perform other quasi fiscal functions, at least not when they would cause inflation. Cukierman, Webb and Neyapti (1992) state that central bank independence and an explicit mandate to pursue price stability are generally regarded as important institutional devices for ensuring price stability.

Cukierman and Webb (2001) provide a critical argument that economists and policy-makers concur that the degree of autonomy of central banks from political authorities is an important determinant of policy choices and economic performance. The issue of central bank independence according to Cukierman, Webb and Neyapti (1992) concerns the balance of authority between the central bank and the executive and legislative branches of government.

Ahsan, Skully, and Wickramanayake (2006) are of the opinion that as long as central banks are created by government legislation, there is always some kind of a relationship between the central bank and the government. They conclude that, indeed, it may not be possible to completely separate them and the debate should therefore focus on the appropriate degree of separation.

The independence of central banks is also important as it ensures the denationalisation of money. However, of concern are the dramatic debt developments that are increasingly undermining the independence of central banks. The intertwining of fiscal and monetary policy is progressing steadily.

Professor Hayek in a Hobart paper published by the Institute of Economic Affairs in 1974 gave a detailed analysis of why money should be denationalized.

According to Khan (2016), central bank independence is critical though a complex concept that has different interpretations. Former Reserve Bank of Zimbabwe governor, Dr Gideon Gono admitted in an interview with Trevor Ncube that the central bank is the elephant in the room that requires restructuring to ensure its independence. Without restructuring, Dr Gono argues that the country will continue to suffer economically. Khan (2016) provides the following four distinctions of central bank independence:

Political independence

Central banks formulate and execute their monetary policy without the undue political influence of the executive and/or legislative power. Examples of checks and balances to this extent can be found in legal requirements on the approval and dismissal procedures for central bank governors (and board members in general). Some countries require a “double veto”: both the executive power (for example, the minister of finance) and the legislative power (the parliament) or even judicial power (the courts) need to be involved in the hiring and especially firing of a governor, to avoid “politically inspired changes”, for instance after a general election.

Also, reasons for firing a governor should be laid down in the central bank’s law. The political independence of central banks has always been the institutional guarantor of confidence in the stability of the currency. The closer the liaison between monetary and fiscal policy grows, and the longer it persists, the greater the likelihood of a loss of confidence.

Operational independence

Central banks should be severely limited in/prohibited from financing public sector expenditure, to avoid the harmful impact on inflation of financing the fiscal deficit with central bank money.

Central banks are free to formulate interest rate policy, and its execution is an exclusive responsibility of the central bank.

The central bank cannot really be independent from the Treasury, because the central bank is the government’s bank, with almost all payments made by and to the government running through the central bank (Wray, 2014). As such, there is no “operational independence” that would allow the central bank to refuse to allow the Treasury to spend appropriated funds.

In any event (Wray, 2014) states that, nothing is more sacrosanct than the supposed independence of the central bank from the treasury, with the economics profession as well as policy-makers ready to defend the prohibition of central bank “financing” of budget deficits.

Financial independence

The government should ensure the central bank’s capital integrity to support the central bank’s policy independence. In return, the central bank transfers profits to the government after accumulating appropriate legal reserve provisioning. Financial independence allows the central bank to conduct open market operations without financial restrictions, and to try and achieve its policy goals. Besides, the central bank should not engage in quasi-fiscal operations, which on most occasions deteriorate its financial position. Central bank financial independence and the transparency of its financial relations with the government facilitate accountability.

Legal independence

This is not so much the fourth category, but rather a crosscutting component for all forms of independence. First, it indicates the degree of independence that legislators are meant to confer on the central bank. Second, practically all existing attempts at systematically characterizing central bank independence rely solely on legal aspects of independence.

  • Maune is a Talmudic scholar, researcher, and consultant as well as a member of IoDZ. To comment on this article, contact him, at alexandermaune6@gmail.com.

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