Central Bank Independence and its Role During Financial and Economic Crises Dr. Shamsuddeen Usman Chairman/CEO Susman& Associates A Lead Presentation at the Symposium at the 38 th Ordinary Meeting of the Assembly of Governors, Association of African Central Banks, Malabo, Equatorial Guinea 13 August 2015 1
Central Bank Independence and its Role During Financial and Economic Crises Introduction My selection as the first speaker at the first plenary. Focus on key issues, highlighted by some Nigerian examples. 37 Governors in Nigeria, with 36 States. 37 th Governor is most powerful. In 2005, Italian Central Bank Governor, Antonio Fazio, said by some to be more powerful than the Pope. Led to resignation of Italy s then Finance Minister, Domenico Siniscalo. A number of key, serious issues involved in the Central Bank Independence Debate. 2
2. Why the Need for Central Bank Independence? A number of key reasons advanced: Inflation/growth trade-off only in the short-run; in longrun, choice not politically sensitive. If monetary policy is left to politicians, the s-r inflation/growth trade off would be predominant: higher inflation less than optimal growth Government policy makers often tempted to seek s-t growth, at expense of l-t inflation. Finance Ministers focus on minimizing borrowing cost, even at risk of overheating economy. Therefore, better to leave monetary policy to Central Bank technocrats, insulated from political considerations. 3
3. Mechanics of Central Bank Independence Important to distinguish between de jure and de facto independence. 3.1 Key Elements of de jure Independence A comprehensive, Central Bank (CB) enabling law that clearly specifies: Key objectives of the Bank Secure, medium-long term tenure for the Governors. Conditions for appointment, removal/termination of the Governors. The CB s Financial Independence: Self financing and Not lending directly to the government or its agencies. 4
3.1 Key Elements of de jure Independence (cont d) Government s participation in the governance of the CB and if it can veto any of the CB s decisions Who the Bank is accountable to: Executive or Legislature? Recent studies shown that: de jure, Central Banks far more independent today than in 1980s, especially in emerging markets and developing economies. 5
3.2 Key Elements of de facto Independence Extent to which legal provisions are adhered to, in practice. What independence political, policy operational (instrument)? Extent of CB s transparency and accountability especially to the wider public. Can parliament, professional economists, financial analysts and general public discuss and criticize decisions and actions of monetary authorities? What is (reporting) relationship of the CB Governor to: President/Prime Minister? Finance Minister? Parliament? 6
4. What Has Been Effect of Central Bank Independence - Under Normal Circumstances? - During Financial and Economic Crises? Under Normal Circumstances: Increased independence has enhanced CBs achieving key objective of monetary stability Enhanced CBs credibility, leading to reduction in cost of conducting monetary (and regulatory) policy A number of studies shown that: Formal CB independence alone, not enough Also need rules-based framework for monetary policy 7
4. Effects of Central Bank Independence (Cont d). During Economic and Financial Crises The crux of my presentation today CB Independence almost holy grail, until 2007-2009 Global Financial Crisis (GFC) Along with narrower definition of CB role as achieving non-inflationary growth GFC now reopened the debate around 2 fulcrums: Effectiveness of monetary (and regulatory) policy during crises and Transparency and accountability of consequent policy and actions by the CB. We look at these in greater detail. 8
4. Effects of Central Bank Independence (Cont d). Effectiveness of Monetary Policy Under Crises In case of US Federal Reserve. Quantitative Easing a seeming triumph of monetary over fiscal policy. Yet impact nearly same, as Fed ended holding substantial portion of the debt and bank reserves grew to historic levels. As testified also by 2011 BIS Annual Report, several years after the GFC, many of the global weaknesses remain. BIS Report also called for bold action by governments as limit of monetary policy been reached. Tendency for fiscal side to cause the problems and allow monetary side to carry the can and the blame. 9
4. Effects of Central Bank Independence (Cont d). Other People, however, saw things differently. CBs not learnt the lessons of history by tendency to set aside economic rigourfor obsessive focus on price stability. Enormous economic power given CBs following GFC led some to overreach into areas beyond monetary policy. This overreach, likely to prove corrosive to CB independence and the democratic process. Some argued that monetary policy had lost touch with reality US example: where stock market responds more to Fed interest rate changes than companies balance sheets and P&Ls. 10
Transparency and Accountability of Monetary Policy Actions Enormous powers and overreach by CBs during crises often called to doubt transparency and accountability of their actions. Increasing CB independence has moved monetary policy to sidelines of political process. Therefore, calls to reduce powers of CBs to bring them back into democratic process. A related argument is that CBs reaction to the sub-prime crisis made central banking much less technocratic. In a number of cases CBs involved in horse trading with politicians to retain or increase their independence the US Dodd-Frank Act. 11
Transparency and Accountability of Monetary Policy Actions (Cont d). Empirical study by Acemoglu, Johnson, Robinson and Querubin showed: CB independence reforms tended to reduce inflation. Effect of reducing inflation, however, small or absent in countries with weak or strong institutions. 12
Recent Nigerian Experience Critical issues around CB independence been playing out in Nigeria: What is role of CB and its Board? How independent is the Board? What are limits of authority for Bank, Board, Governor? Who has power to suspend Governor and under what circumstances? Is the CB answerable to National Assembly (Parliament) and to wider public? How narrow or wide is the mandate of the CB, especially during economic and financial crises. 13
..Recent Nigerian Experience (Cont d). Under Governor SanusiLamidoSanusi(SLS), charges that CBN was overbearing and went beyond its limits, e.g. Bailout of 9 undercapitalized banks, costing US$4.2 billion without approval of National Assembly Creating AMCON in 2010 to purchase toxic assets of banking industry at face value of about US36.6 billion. Quantitative Easing that injected hundreds of billions of Naira via a 10-15 year debenture stock. CBN countered that all its actions were in public interest and within its remit. CBN also pointed out its relative success in fighting inflation. 14
..Recent Nigerian Experience (Cont d). Here distinction between de jure and de facto independence is relevant. Most of above and other policy actions recently taken by CBN are covered by CBN Act. Most of the actions also within CBN s remit. But how much consultation with Executive, Legislature and general public is necessary and when? National Assembly increasingly in the fray 2 Restructurings of the currency by Governor Soludo: First restructuring in 2005-2006 Then proposed redenomination in 2009 Proposed Currency Restructuring by SLS de jure approval Outcry by National Assembly and public Calling for CBN Governor s head...also for his and CBN s wings to be clipped. 15
..Recent Nigerian Experience (Cont d). While I am sympathetic to CBN s point of view: Even though some policy measures and actions controversial, unlikely to have been successful if subjected to the political process. That doesn t answer question of transparency and accountability: who is the Regulator accountable to? A number of people now saying: Monetary policy is too important to be left to Central Bankers 16
..Recent Nigerian Experience (Cont d). Corollary: call on CBs for greater transparency and accountability of monetary and financial regulatory policy...ultimately, CBs can achieve their goals and control inflation, only if their integrity is without question. (WJ McDonough) Theme of this Symposium: Central Bank Independence -Myth or Reality? Our answer: It is a reality, surrounded by so many myths. 17
Thank You. Dr. Shamsuddeen Usman Chairman/CEO Susman & Associates 18