47 Political Economy of Central Bank Independence - Jamal

Political Economy of Central Bank Independence
[Author: Dr Jamaluddin Ahmed FCA is the Treasurer of Bangladesh Economic Association, Vice-President of the Institute of Chartered Accountants of Bangladesh (ICAB), Partner of Hoda Vasi Chowdhury & Co, Chartered Accountants-an Affiliate Firm to Deloitte Touch Tohmatsu] Many governments wisely try to depoliticalise monetary policy by, for example, putting it in the hands of unelected technocrats with long terms of office and insulation from hurly-burly of politics -Blinder (1998), pp. 56-57.
What Shapes and What Shakes it?
Introduction
Interest in the topic of Central Bank Independence has grown significantly over the recent years. Key analyses of the relating to Central Bank Independence are ample. See for example, Cukierman (1992, 1996), Fischer (1995a, 1995b), Goodhart (1994) and Volcker (1990, 1993). Excepting the capitalist countries, the basic feature of Central banking under command economy was the high concentration of decision mking power in the economy and the central role in it was on the politicians (Communist Party). When private property ws abolished by the decree of nationalisation, entire financial system became state owned by merging most of the financial institutions. The change to this system after September 1944 can be traced to the writings of Lenin, the founder of the Soviet State. Lenin saw it thus: ....to proceed with bank natinalisation and to come closer in transforming them into strategic points of socialist public book keeping, first of all we have to achieve a real success in increasing the number of the National Bank branches, in attracting deposits, in facilitating the citizens in their paying in and withdrwals from the bank, in liquidating the queues (in front of branches), in catching and shooting speculators and the ones taking bribes. Adopted: In Selected works of Lenin (1987) Sofia, Partizdat Vol-7, p. 175 The communist parties justified the creation of state monopoly on the ground that property gives rights to one or small groups of people of individuals, inimical to the interets of society as a whole. Control of the economy required the concentration of all property in the hand of the central government. Accordingly, one tier socialist banking system was created where the central bank its traditiotional activities with those of commercial banks and for that reason this was termed as MonoBank. This concentration of control in one institution meant that information on money flows was readily available and thus readily subject to control whenever required. Since the collapse of command economy and from 1989 to the present, almost 30 central bank laws were revised, were rewritten, and all in direction, namely strengthening the independence of the Central Bank. It is true about industrial countries, such as the UK, USA, France, Belgium and Italy. True about Latin American countries such as Argentine, Chile, Mexico, and Venezuela. It is true about the Republics that belonged to the former socilist countries. According to modern theory of central banking the monetary institutions can be described by the political and economic independence of central bank. The political independence is defined as the ability of the central bank to choose monetary policy goals autonomously and without interference from the government. The basic determinats for this ability are found in personal independence (i.e., procedures for appointing and dismissing central bankers, term of office), in the governments right to give instructions to the central bank as well as the right to veteo, to
suspend or to defer central banks decision, and its right to be present on the central bank board. Furthermore, the degree of political independence depends on the formal responsibilities of the central bank. The economic independence is defined as the ability of the central bank to determine the use and the choice of its monetary policy instruments automonously and without interference from the government. Economic independence may be adversly affected by the central banks obligation to finance the government budget, to supervise commercial banks and by lack of freedom to set interest rates. In addition, the question of who in charge of exchange rate policy, is to be addressed wheather it is the government or the central bank. Objective of this paper is to carry out (i) a literature review on the theoretical basis of Central Bank Independence (CBI), (ii) conduct a comparative study on the legislative issues relating to the structure and functions of some selected Central Banks and compare to those of Bangladesh, (iii) review available indexes of measuring the CBI and fit those with that of Bangladesh, (iv) summarise the findings and (v) suggest recommendation for Bangladesh. Traditional views on central bank Independence The traditional justification of the central bank independence necessity is funded on the argument that this independence constituted a mean through which the central bank ensures the stability of prices. Why would central bank idependence yield lower rates of inflation? Three arguments are discussed in the literature: 1 Those based on bublic choice arguments: according to this view, the monetary authorities are exposed to strong political pressures to behave in accordance with the governments preferences. When the economy slows down, the government may prefer a more relaxed monetary policy, to re-launch the economy. Those based on the analysis of Sergent and Wallace (1981): they distinguish between fiscal authorities and monetary authorities. This argument relates tot he financial independence and states that if central bank is dominant than it can oppose to finance the budgetary deficit by creating money, Or, if the fiscal policy is dominant, then the money supply becomes endogenous and the monetary authoritis cannot influence the size of the governments budget deficit. Indeed, as John Maynard Keynes earlier (1923) emphasisesd A government can live for long time by printing money...... it is the form of taxation which the public finds hardes to evade and even the weakest government can enforce, when it can enforce nothing else. Those based on the time inconsistency problem: Kydland and Prescot (1977); Calvo (1978); Barro and Gordon (1983), argue that the dynamic inconsistency arises when the optimal decision made in th epresent period for future one,, is no longer optimal when that period actually starts.
Milton Firemans contribution to central bank issue (1977) was to rlate it to the variability of inflation. In his nalaysis, Friedman expalined why there could exist a positiove correlation between the level of inflation and the vaiability of inflation, across countries and over timefor any country. He argues that government may pursue policy goals, like the level of output and employment, that can lead to high inflation ; only an independent central bank , can oppose to issueeasy money.
It is interesting to note here that the mentioned mission given to central bank constitution a simple statement unless accompanies by an operational disposition rgarding the means that can be used to achieve this mission an by an object criteria to define the concept of price stability. Consequently, the respective mandate entrusted to the central bank, improper if directly used and interpretable, may be considered as rule (i.e., statement fixing the reference framework in which the decision are adopted and in which the bank function), if pursuing political regime based on representative democracy and historical evalution of the central bank and the exclusiveness of its control over financial and monetary system. The importance of such a rule does not consist in its operational character but in the fact that it forces tha bank to coceive a strategy whose anticipation by the economic actors can be a source of ecomonic stabilleaving a certain flexibility of action. The independence of the central bank is justified by the fact that it allows the increase of crediability of the anti-inflationary policy conceived by the monetary authority. A possibility to solve partially the cridiability problem is the independence of the central bank , i.e.the separation of the monetary policy decision of the pressures of other political authorities. Gradual support for indepependent central bank gains once the country positions itself towards market economy shifting from the high degree of centralisation. Financial system under centralised economy was a monolithic instrument for managing socialist economy which differs fundamentally from that of market economy. Financial processes are considered subordinate to physical flow under command economy by contrast the financial process dominates physical flows under the market economy. The financial system play minor role under the command economic system and monatary system is not an allocator of resources but in the market economy finance is prominent in decision making. Under command economy, the financial institutions are considered as of secondary importanc in comparison with administrative institutions that directly manage the physical flows. The monetary demand under central planning influenced directly neither the volume nor the structure of production and, therefore, the role of money was considerably limited including the sphere of the use of instruments, markets and financial institutions. By contrast, under the market economy, the monetary and financial system is the key deciding factor for physical flows. The independent central bank is considered to play role to develop efficient financial system. Developing countries have enforced institutional reforms concerning the relationship between government and central bank. Countries in the Hempshere, for example, Argentina, Chile, Colombia, Mexico, and Venezuela, have been atempting to secure their stabilisation progressby providing their central banks with more legal independence (Siklos 1995; Cukierman 1996).Apart from creating independent central banks by law some countries enforced additional specific mechanisms to make central banks explicitly accountable.If the inflation targets are set by the government for a defined period, or agreed between the government and the central bank, inflation targeting forms an alternative institutional design for an independent central bank which stresses the accountability of the central bank. In this sense, inflation targeting is aimed at preventing a democratic deficit which can emerge when political decisions are taken by an authority which is not directly legitimated by elections (Briault, Haldane, and King, 1997; Nolan and Schaling 1996). Three main reasons have been put forward by Debell and Fischer (1994, p.195) for the eststablishment of independent central bank:
First: central bank independence is justified theoreticaly by the existance of incentive constraints
for politicians that force dependent central banks to realise suboptimally high rates of inflation
(Persson and Tabellini 1997). Since the study by Kydland and Prescott (1977) this inflation bias has ben discussed primarilyagainst the background of the credibility problems of monetary policy caused by the dynamic inconsistency. In addition , the political independence of the central bank is aimed at protecting against partisan or electoral cycles in monetary policy (Alesina 1988, p.40; Alesina and Roubini 1997, p. 212), which in combination with ex ante uncertain election outcomes in turn may lead to suboptimally high output volatility and contribute to a higher inflation bias (Alesina and Gitti 1995).
Second: numerious empirical studies (Eijffinger and Fe Haan 1996 for a survey) claim that in industrial countries legal measures of central bank independence are inversely related to the average inflation. In contrast, there is no systematic relationsship between central bank independence and economic growth. In the case of developing country it is observed that legal independence of central banks is not a good measure of actual central central bank independence. The negative correlation between central bank independence and inflation is confirmed, however, if so called behaourially oriented indices like actual turnover rates of central bank governors or the political vulneribility of the central bank governor are used to measure the degree of central bank independence (Cukierman 1994, 1996). Third: moreover the track record of the German Bundesbank which is regarded as particualrly independent central bank is referred to.
Reasons for move towards strenthening of central bank independence can be identied. First: countries that were successful in maintaining low inflation have typically enjoyed better economic performance than countries that were unable to contol inflation. Second: the world has undergone a conceptual revolution in contrast with previous belief that there is no long term trade-off between inflation and unemployment and this conceptual revolution has yielded the conclusion that price stability controbute to good economic performamce while inflation is a source of instability and economic cost. Third: there has been a fundamental change in the views about the role that governments and economic policy can and should play in the market economy in place of command economy with a growing conviction that free enterprise led by private sector is the best framework whithin which one can generate. Finally: there is also a growing conviction that in order to promote investment and growth one needs to general price stability and the new view about the role of government and the desire to promote sustainable growth within a market economy, brought about renewed interest in the conditions necessary for price stability. Four important historical developments took place in the past few years and that contributed to the growing interest in central bank independence. First: the creation of European Central bank specifying that it must be independent and its main objective must be price stability, keep distance from the governments and, thereby, it should be kept free from political pressures, etc. This process heightened the official interest in, and the publics awareness and familiarity with the topic of central bank independence. Second: development that stimulated interest in the subject was the urgent need to create several new central banks due to the collapse of the Soviet Union that brought about the creation of Independent Republics. These new republics have realized the need to have new central bank that is independent. Third: experience of sufferings from high inflation in several Latin American countries was associated with having weak and not siffiently independent central banks. The fourth development has been the emergence of globalised capital markets and before entering into the competitive capital narket country credit
rating is an important element. These ratings depend heavily on the countries track record of fighting inflation and on the institutional setting that governs the economic policy making. Added to these, prominent among such institutions is the presence of indpendent central bank. There are two conncepts of independence. One focusses on goal indpendence and the other on instrument independence. The goal independence is found for example in the German case in which the Bundesbank does not get any instruction from the government. The Bundesbank sets its own goal and then uses the available instruments in order to meet the goal. With instrument independence, the tragets are set by the government and the central bank is completely free to use the policy instrument at its disposal in order to meet the assigned target. In addition, central bank is free from any obligation to finance the governments budget. The complete separation between the policies of the central bank and the budgetary needs of the government, is put in order to ensure that the intrinsic governments inflation bias does not result in an actual inflation bias. In addition to the distinction between goal and instrument indpenednece, the very concept of central bank independence requires further classification. One needs to distingush between legal indendence that can be inferred from the language of of the law, and actual indendence that depends on the actual practice and on the way in which law is being interpreted and implemented. For example, in many developing countries, it is difficult to assess the actual degre of central bank indpendence from analysing only the language of central bank law, because the text of the law is convincing, but record of implementation is not. In other countris, on the otherhand, the provisions contained in the formal central bank law are not strong but yet, the actual degree of indpendence is nevertheless impressive. In summary, the issue of central bank independence is not just a juridical issue but rather, it is a practical one. The empirical and theoretical justification for central bank independenare not undisputed in the literature. In some cases, the consistency of indices based on interpretation of central bank statues is disputed in general and in particular concerning some concrete indices (Mangano 1997; Eijffinger and Schaling 1995). In addition the originally maintained correlation between central bank independence and macroeconomic variables are not always confirmed (Campillo and Miron,1996; Fuhrer 1997), the causality between central bank independence and inflation is disputed (Posen,1993), and higher disinflation costs as result of a higher sacrifice ratio with central bank independence are also calimed (Debelle and Fischer 1994; Fischer 1996; Jordan 1997; Hutchison and Walsh 1997). Furthemore the theoretical foundation of central bank independence, as paer as they are based on the problem of time inconsistency , have not yet fully reasearched. In this context there is increasing criticism that institutinal reforms do not really solve the crediability of th problem, but merely relocate it (McCallum, 1995; Al-Nowaihi and Levine 1996; Jensen 1997; Illing 1998). Studies were carried out to examine the issue of independence defined variuos indices of independence including provisions of law, as well as the actual practices. Examination of data revels strong evidence that in general countries with an independent Central bank have enjoyed better economic performance and in particular have had a much better inflation record than countries with lesser degree of independence. Questions that were examined in this context inquired about the length of the term of the governor; about the dependence of this term on the timing of changes in governments; does the new government have the power to replace the governor prior to the end of his term; should interest rate decision can be taken by a Board and how many persons should be included in such
Board? How many of the Board members should be insiders, how manuy outsiders? Can the members of the Board earn salaries from other sources? Who determines the budget of the central bank? What happens when there is disagreement between government and the central bank? Who determines the inflation target? Is the bank endowed with all instruments needed for the conduct of monetary policy or does it need to get government approval at each case? In what way and to whom is the bank accountable? One of the important asset of a central bank is its crediability that is an essential element for making a central bank an independent one. There is famous dictum according to which crediability is never owned, it is only rented and a central bank must continually invest in crediability and, thereby, establish a track record. Through the track record central bank can accumulate crediability which is viewed as an asset and is a form of capital and every mistake may be very costly because it may result in a rapid depreciation. This asset is also reffferred to as reputation that is considered a precondition for adoption of long term apprach to economic policy. This can only be provided only if the central bank is granted strong independence. Thus, crdiability enhances the effectiveness of monetary policy and central bank independence enhances crdiability. Bank supervision and and independent central bank is another issue that subject to debate in the context of designing an independent central bank is whether the function of bank supervision is part of the central bank or not. In most countries bank supervision is part of the juridiction of the central bank, but in some the practice differs, In Germany, for example, bank supervision is not under the auspices of Bundesbank. The German view is that since the main objective of the bank is the attainment and maintenance of price stability, any other consideration, like those introduced by the responsibility of bank supervision which has to be concerned with the stability of banking system, may compromise the main goal and, thereby, upset the focus of the central bank on price stability. Recent discussions on constitutional political economy have been emphasised on the need for a central that is independent of the executive (Cukierman 1992; Canzoneri, Grilli, and Masson 1992). The operation of central bank is usually established by the statute rather than by the constititon. On might well as, therefore, whether independece is really possible in Parliamentary stystems, since the govrnment controls the legislature. The argument for an independent central bank is the need to prevent the govrnment from engaging in highly inflatinary policies. Beacuse of the desire for re-election, for instance, the time horizon of the government might excessively short. Even a government that tries to maximise the welfare of society rather than its own political fortune will run into problem of time inconsistancy (Kydland and Prescot 1977). If a policy of no inflation is announced and the public believes it, the government has an incentive to deviate from it. Hence there is no need to to remove discretionary control over monetary policy from the government. Assuming constitutional law makers accept this premise, they might opt for rules rather than to discretion and write a specific monetary policy directly into law or constitution. But a simple rule, while feasible, would provide too little flexibility for adjusting to unforseen events, while the rule that tried to specify optimal response to all contingencies would be impossibly complex. Alternatively, policy makers may entrust fiscal discretion to an independent central bank rather than to the government. Information do suggest that countries have adopted different measures to ensure the real indepence of the governor of the bank.
Box 1: Summary of Best Practices on Central Bank Independence and Accountability

Criteria
Best practices
Establish a single of primary objective in terms of preserving price stability. If there are multiple of objectives (for example, price stability and financial system stability), any policy conflict that arises should be resolved in favor of price stability Central Banks Board of Directors must be nominated and appointed by the government and Congress in a two-step process, without any representation of the government or the private sector. They should be appointed for term longer than that of the presidential term, and grounds for dismissal should be solely of a legal nature and clearly established in law. Although the central bank Board of Directors itself or the government should take initiative for the dismissal of a board member, the Legislature or the Judicial Branch should bear the final decision. Provide central banks with instrument independence, that is, the freedom to use all the means to achieve the inflation target. Interest rate policy should be the exclusive responsibility of the central bank, while the selection of the exchange rate regime may be shared with the government, such that it does not interfere with the conduct of monetary policy and the achievement of the policy target. Goal independence, for example defining unilaterally an inflation target, implies a stronger independence but assigns the central bank the responsibility of driving the short-run trade-off between inflation and unemployment, which is more in the nature of the political authorities decision. Direct credit to the government should be prohibited or carefully limited in line with the policy objective. Define clear rules governing the relationship between the central bank and the government in the treatment of central bank losses and profits. Government should commit to maintain central banks capital such that monetary policy is implemented without financial restrictions and focused on established policy objectives, while central bank profits should be transferred to the government after an appropriate accumulation of central banks legal reserves. The central bank should report to the government and the Legislature on the conduct of monetary policy, and in particular on the achievement of the longrun inflation policy and the implementation of actions and policies to that end. Such reports should be given broad public dissemination. Financial statements should be published at least once a year under generally accepted accounting principles, and should be certified by an independent auditor. Summary balance sheets should be published more frequently under similar accounting standards, supplemented with relevant explanatory notes.
Clarity of Objectives Political autonomy
Economic autonomy
Financial autonomy
Accountability
Luis I. Jacome H, (2001): Legal Central Bank Independence and Inflation in Latin America : IMF Working Paper, Monetary and Exchange Affairs WP/01/212
Box 2. Central Bank involvement in banking crises resolution (Selected country cases in Latin America)
Ecuador (1998-1999)
EL Salvador (1998)
Guatemala (2001)
Venezuela (1994)
The banking crisis of 1998 and 1999 led to the closure, or the taking over by the State, of 16 banks (65 percent of total assets), including four of the five largest banks. The Central Bank of Ecuador (CBE) was actively involved in this crisis, initially through LOLR facilities, and subsequently via the payment of deposit guarantee claims. In return, the CBE received fixed assets and the lending portfolios of those institutions, as well as government paper. As a result, the CBEs assets Grew by a factor of 12 between 1997 and 1999. The size of the crisis made it impossible to sterilize monetization in full, and control over monetary policy was therefore lost. CBEs financial statements did not show losses associated with these transactions because the CBE charged a penalty interest rate on its liquidity loans and because government paper was discounted at market values. However, provisions stemming from bad loans were not made in accordance with international standard, and thus its balance sheet does not reflect its true financial position. During the Credisa Bank crisis- a medium-sized financial institution the bank initially received liquidity loans from the Central Reserve Bank (CRB), which then got involved in solving the crisis. As part of the banking resolution strategy, the CRB made a swap, providing liquid assets to the four acquiring banks of Credisas deposits and receiving Credisas impaired assets. The CRB sterilized monetization by issuing long-term paper that was purchased by the four banks, and used them to comply with central bank reserve requirements. The CRB has begun to liquidate the acquired assets, but losses will not be absorbed by the CRB, as initially planned, because the recent adoption of dollarization requires the cleaning of the CRBs balance sheet. The cost of intervention of three small banks (about 6 percent of total deposits) has been absorbed for the time being by the Bank of Guatemala (Banguat), with no government involvement. Earlier, Banguat provided liquidity loans against assets of the three problem banks. After intervention took place, the Monetary Board authorized Banguat to extend a line of credit to the intervened banks to pay their obligations, primarily to depositors. These funds were provided without receiving any collateral in exchange. Since the crisis was of minor dimensions, Banguat sterilized monetization through OMOs. Banguat will presumably absorb the losses that will be generated when the three banks are liquidated, as the government has no legal requirements to compensate central bank losses. However to date Banguat has made no provisions to cover such losses. The systemic banking crisis in Venezuela required an intensive involvement of the central Bank of Venezuela (CBV). After the collapse of Banco Latino the countrys second largest bank- another 12 banks were subsequently taken over by the State or closed in 1994 and 1995. The CBV provided LOLR resources directly to a number of institutions or indirectly via the deposit insurance fund (FOGADE) initially at market interest rates and latter at below market conditions. In return, the CBV received assets of the problem banks and claims on FOGADE, which did not fully cover the emergency assistance provided. Sterilization inflicted a high cost to the CBV and in the end was insufficient to completely absorb the excess liquidity. As of today, government obligations to the CBV has not been settled down. In the mean time, the government has been covering only marginally CBVs claims, while at the same time it has extracted from the CBV significant resources to finance public expenditure stemming from CBVs unrealized accounting profits.
Table 1. Index of Central Bank Independence and accountability (Criteria, Values, and weights)
Criteria (Weight) 1. Central Bank Objective (2)
0.5
2. Appointment and term of office of the members of the Central Bank Board (2) 3. Structure of Central Bank Board (2) 4. Removal of Board Members (2)
5. Central Bank credit to government (3) 6. Lender-of-lastresort (2) 7. Instruments independence in the conduct of monetary policy (3) 8. Financial independence (1)
Preserving price stability is the single objective. If more than one conflicting objective, price stability has priority. Nominated (appointed) by government and appointed (confirmed) by Congress. Term in office exceed or overlap government period. No private sector and government representatives, except Min. of Finance without vote. Two- step process, with qualified majority under strictly legal grounds. Final decision by Congress of Judicial Court No direct credit, except in clearly regulated emergency situations. Or through the secondary market, with limitations. Emergency loans legally regulated, including limits to the amount to be granted. Total independence in the use of monetary instruments. Government assures central bank capital integrity. Central bank transfers profits to the government after proper provisioning. Central Bank Governor appears before Congress and reports to government. Report disclosed on a timely basis. Publishes periodically financial statements certified by an external auditor.
Multiple conflicting objectives without establishing that preventing price stability has priority. Nominated and appointed in a two-step process for same term in office than government without overlap, or directly for longer term. Direct government representation, including Minister of finance with vote. Directly by the Executive branch under strictly legal grounds, or in two-step process under non-legal basis. Direct credit with limits, via secondary market without limits, through overdrafts, or indirectly via public banks. Emergency loans legally regulated, without limits to the amount to be granted. Government involvement in formulation of monetary and exchange rate policy. Government not required to assure integrity of central bank capital. External approval of Central Bank budget. Reports only to the government on a regular basis or when there are monetary disturbances, plus an annual report. Publishes financial statements with the approval of a public sector auditor.
Multiple objectives, including growth, an orderly development, or economic development, without priorities. Appointed directly by the government for the same or shorter period than the government. Direct government plus private sector representatives (bankers, entrepreneurs, etc) Removal by the Executive branch for subjective or political-not legal grounds, or by the private sector. Direct or indirect credit without limits.
Discretionary policy for emergency loans and provisions for bank resolution. Limitations on the use of monetary instruments (reserve requirements, interest rates). Central bank conducts quasi-fiscal operations. No government capitalization required. Central bank only publishes an annual report.
9. Accountability (1)
10. Transparency and disclosure of financial statements (1)
Inappropriate accounting procedures. Publishes financial statements with the seal of internal auditor.
Table 3. Central Bank Independence and Accountability ( Country evaluation)

Criteria (Weight) 1. Central Bank Objective (2) 2. Appointment and term of office of the members of the Central Bank Board (2) 3. Structure of Central Bank Board (2) 4. Removal of Board Members (2) 5. Central Bank credit to government (3) 6. Lender-of-last-resort (2) 7. Instruments independence in the conduct of monetary policy (3) 8. Financial independence (1)
1
Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Honduras, Mexico, Peru Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Mexico, Paraguay, Venezuela Argentina, Bolivia, Brazil, Chile, Honduras, Mexico, Paraguay, Uruguay Argentina, Chile, Colombia, Dominican, Republic Honduras, Mexico, Peru Argentina, Chile, Guatemala, Mexico, Peru, Venezuela Argentina, Peru, Uruguay
0.5
Paraguay, Uruguay
0
Dominican Republic Guatemala, Venezuela Dominican Republic, Guatemala, Honduras Dominican Republic, Guatemala Brazil, Guatemala, Uruguay, Venezuela
Peru, Uruguay
Brazil, Colombia, Costa Rica, Venezuela Bolivia, Costa Rica, Paraguay Bolivia, Brazil, Colombia, Costa Rica, Dominican Republic, Honduras, Paraguay, Uruguay Costa Rica, Colombia, Honduras, Mexico Mexico, Paraguay, Venezuela
Bolivia, Brazil, Chile, Dominican Republic, Guatemala, Paraguay, Venezuela
Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Guatemala, Honduras Peru, Uruguay Colombia, Peru
9. Accountability (1)
10. Transparency and disclosure of financial statements (1)
Argentina, Bolivia, Brazil, Chile, Colombia, Honduras, Mexico, Uruguay, Venezuela Argentina, Brazil, Chile, Mexico
Argentina, Bolivia, Brazil, Chile, Costa Rica, Guatemala, Honduras, Mexico, Paraguay, Uruguay, Venezuela Costa Rica, Dominican Republic, Guatemala, Paraguay, Peru Bolivia, Colombia, Paraguay, Peru, Uruguay, Venezuela
Dominican Republic
Costa Rica, Dominican Republic, Guatemala, Honduras
Structure of Central bank
In many countries constitution is not of course the place to regulate in detail central bank issues, and some countries do not even mention it in their acts at all, but the majority of European constitutions were written when central banking was not considered so important and an independent aspect of the national financial system as it now. Poland (1992) gave constitutional support to the regulation of the Ploish central bank is considered important to overcome a historically rooted consciousness which still exists from when the central of Poland ws functionally a part of Ministry of Finance. This experience coexists with the present lack of understanding and acceptence by a large part of society and by many politicians of the role of modern central bank. The central bank of Norway, created in 1816, was located in Trondheim, several hundred miles from the capital and from the seat of the government. In countries with dual executive, the central bank governor may be appointed by the president rather than by the government, on assumption that governor would than be more likely to be conservative than activist, that is, to place greater weight on pricce stability than on employment. The constitution may also explicitly forbid the government from instructing the bank or require that it make its instructions public. Furthermore, price stability may be constitutionalised as the goal of the central bank. One may also try to strengthen the bank by taking away some of its power following the sprit of Schelling (1960). To protect the bank from informal pressure from the government, therefore, the bank could be explicitly forbidden from engagging in dificit funding. Grill, Masciandro and Tabellini (1991) Index of Political Independence
1 2 3 4 5 6 7 8 Political Independence Governor not appointed by the government Governor appointed for more than 5 years Board members are not appointed by the government Board members are appointed for than five years No government official represent at the Board Yes No
No government approval of monetary policy is required Is the bank required to pursue monetary stability Are there legal provisions that strenghten banks position in case of conflict with government Overall index of Political Independence (8) and actual score of Bangladesh Economic Independence 1 Is the direct credit facility not automatic 2 Is the direct credfacility based on the market interest rate 3 Is the direct credit facility temporary 4 Is the direct credit facility of limited amount 5 Does the central bank not participate in th eprimary market for public debt 6 Is the discount rate determined by the central bank 7 Is the supervision not entrusted to the central bank 8 Is the banking supervision not entrusted to the central bank alone Overall index of Political Independence (8) and actual score of Bangladesh Yes No
Alesina and Grill Index (1992)

Political Independence 1 Governor not appointed by the government 2 Governor appointed for more than 5 years 3 Board members are not appointed by the government 4 Board members are appointed for than five years 5 No mandatory participation of government representative in the Board 6 No government approval of monetary policy is required 7 Statutory requirement that central bank pursues monetary stability 8 Explicit conflicts with the government is not possible Overall index of Political Independence (8) and actual score of Bangladesh Economic Independence 1 Direct credit facility not automatic 2 Direct credit facility - on the market interest rate 3 Direct credit facility- temporary 4 Direct credit facility- limited amount 5 Central bank does not participate in th eprimary market for public debt 6 Discount rate set by the central bank 7 No portfolio constraints 8 No credit ceiling Overall index of Political Independence (8) and actual score of Bangladesh Yes No
Yes
No
Bade and Parkin Indices of Political Indpendence

Central bank is the highest monetary policy authority Not true Not true True True Budgetary Independence Not true True True True No government members on the central bank council Not true True True True Salries of central bank are determined by the central bank Not true Not true True True Some members of central bank council are appointed idependent from the government Not true Not true Not true True Allocation of profit is determined by the central bank Not true Not true Not true True Degree of Political Independence 1 2 3 4 Degree of Financial Independence 1 2 3 4
Bade and Parkin Indices of Financial Indpendence
Eijffinger and Schaling Indicator of Central Bank Independence (1993)

Central bank is the sole and final policy authority Not true Not true Bank- Government True True No government official on Bank Board Not true True True True True Some appointments Government Not true Not true Not true Not true True Board of Degree of Independence 1 2 3 4 5 policy
Variables for Legal Central Bank Independence- Cukierman, Webband Nayapati (1992)
Variable Number 1 Description of Variables Weight 0.20 Numerical Coding
Chief Executive Officer

a. Term of office Over 8 years 6 to 8 years 5 Years 4 Years Under 4 years at the discretion of the appointing authority b. Who appoints CEO Board of Central Bank A council of the central bank board, executive branch, and legislative branch Legislature Executive collectively (council of ministers) One or two members of the executive branch c. Dismissal No provision for dismissal Only for reasons not related to the policy At the discretion of the central bank board At legislatures discretion Unconditional dismissal possible by executive At exectives discretion Unconditional dismissal possible by executive d. May CEO hold other offices in government? No Only with permission of executive branch No rule against CEO holding another office
Policy formulation
a. Who formulates monetary policy Bank alone Bank participates, but has little influence Bankonly advises government Bank has no say b. Who has word in resolution of conflict? The bank, on issues clearly defined in the law as its objectives Government, on policy issues not clearly defined as banks goal or in case of conflict withinh the bank A council of central bank , executive branch, and legislative branch The legislature, on policy issues The executive branch on policy issues, subject todue process and possible protest by the bank The executive branch has unconditional priority c. Role in the governments budgetary process Central Bank active Central bank has no influence
Objectives
Price stability is the only objective in the charter, and central bank has the final word in case of conflict with other government objectives Price stability is the only objective Price stability is one goal, with other compatable objectives, such as stable banking system Price stability is one goal, with potentially conflicting objectives, such as full employment No objective stated in the bank charter Staed objective do not include price stability
Variables for Legal Central Bank Independence- Cukierman, Webb and Nayapati (1992)
Variable Number 4 Description of Variables Weight Numerical Coding
Limitation on lending to government

a. Advances (limitation on nonsecuritised lending) No advance permitted Advance permitted but with strict limits (up to 15% of government rvenue) Advance permitted, and limits are loose (over 15% of government revenue) No legal limits on lending b. Securitized lendings Not permitted Permitted,but with strict limits (up to 15% of government rvenue) Permitted, and limits are loose (over 15% of government revenue) No legal limits on lending c. Terms of lending (maturity, interest, and amount) Controlled by the bank Specified by the bank charter Agreed by the central bank and executive Decided by the executive branch alone d. Potential borrowers from the bank Only central government All levels of government (state as well as central) Those mentioed above and the public enterprise Public and private sector e. Limits on central bank lending defined in Currency amounts Share of cenbank demand liabilities or capital Shares of government revenues Shares of government expenditures f. Maturity of loans Within 6 months Within 1 year More than 1 year No mention of the maturity in the law g. Interest rate on loans must be Above minimum rates At market rates Below maximum rates Interest rate is not mentioned No interest on government borrowing from the central bank h. Central bank prohibited from buying or selling government securities in the primary market? Yes No
Indexes Legal Status Opering levels
Romania (i)Head Quarter (ii) Branch in all country capital (iii) Subsidiary in most important cities Parliament on recommendation of Prime Minister 9 members Board is appointed
Czech Republic Head office and Seven regional offices and several specilised operational units
Appointment of Board Government officials at the Board
President Republic
of
the
Poland Not registered as State Owned Enterprise Head Office divided into functional departments, 13 regional branches of more developed acitivity and 36 localbranches of limited activity Diet and the Senate based on propsal of the President
Bulgaria Created by Law of Parliament
Bangladesh Created Ordinance Head offcie Dhaka and branch offices different part the country
by at 8 at of
Parliament and the President
Ministry of Finance and Political Party in power
One member without voting right
Governor, one DG nominated by Govt, four Directors (professional) Nominated by the Govt, four govt officials
6 years term Governor and the Head of issue department 6 years, head of audit 4 and banking 2 years. Members appointed by the President start with mandate of 5, 3 & 1 year. Within one year political and governmental indepence of each member is evaluated. Director (1) Vice Director (3) Other members (3) On the desire of the Ministry of Finance and Party in power
Tenure of the Board
initially 8 years now 5 years
6 Years
Structure of the Board
President as Governor (1) Vice Governor as VicePresident (1) Vice Governors (2) Non-executive memebrs (5)
Governor (1) Vice-Governor (2) Senior Executive members (4)
Council of monetary authority consists with Chairman (Governor) and nine members where nominations are made by President:3, Diect:3 and by the Senate:3
Governor, 4 dy governors (1 from private sector), executive Drector (7), General Manager (30 plus)
Bangladesh
Indexes Appointment of Governor
Romania Parliament
Czech Republic President of the Republic
Poland Diet, Senate President
and
Bulgaria Parliament appoints Director (1) and 3 Vice Directors, the President appoints 3 other Directors
Ministry of Finance and Political regime om power
Recall of Board or any member of the Board or Governor Restrictions on maximum years of service
Parliament
President Republic
of
the
Senate but governor can only be recalled at the end of the term. Same person can not continue longer than 2 consequtive term (12 years) One council of
Not defined
Not defined
Politician
or
Restricted
Allows one member
Ministry of Finance and Political regime in power Decided by the Ministry of Finance and Political regime in power Shadow of
Indexes Parliament members represntation at the Board Budget Preparation
Romania
Czech Republic
Operating departments
Strategy, Foreign Exchange, Monetary Operation, Regulation and Supervision, PaymentClearing and risk, Treasury, Accounting-IT and Statistics, Secretary General, and Logistics
It is ia position of of an entrepreneour in respect of dealing with its property and not paid from state budget Secretariat of the Governor-Public Relation and Organisation department; Regional Branch Offices-Legal Services-Internal Audit and Currency; Monetary-Statistics and Budget; Banking Transaction and and Risk Management;
Poland ministers allowed without voting right but rifght to submit proposals Prepared by the central bank approved by the Council of Monetary Policy
Bulgaria
Bangladesh
Politician s can represent Prepared by the BB and approved by the Ministry of Finance
(i) Issue Department (ii)Banking Department Bank Supervision Department (i) Issue Department (ii)Banking Department
Economists and practitioners in the area of monetary policy generally believe that the degree of independence of the central bank from other parts of the government affects the rates of expansion of money and credit and, through them, important macroeconomic variables, such as inflation and the size of the budget deficit.
Summary There are two conncepts of independence. One focusses on goal indpendence and the other on instrument independence. The goal independence is found for example in the German case in which the Bundesbank does not get any instruction from the government. The Bundesbank sets its own goal and then uses the available instruments in order to meet the goal. With instrument independence, the tragets are set by the government and the central bank is completely free to use the policy instrument at its disposal in order to meet the assigned target. In addition, central bank is free from any obligation to finance the governments budget. The complete separation between the policies of the central bank and the budgetary needs of the government, is put in order to ensure that the intrinsic governments inflation bias does not result in an actual inflation bias. In addition to the distinction between goal and instrument indpenednece, the very concept of central bank independence requires further classification. One needs to distingush between legal indendence that can be inferred from the language of of the law, and actual indendence that depends on the actual practice and on the way in which law is being interpreted and implemented. For example, in many developing countries, it is difficult to assess the actual degree of central bank indpendence from analysing only the language of central bank law, because the text of the law is convincing, but record of implementation is not. In other countries, on the otherhand, the provisions contained in the formal central bank law are not strong but yet, the actual degree of indpendence is nevertheless impressive. It is argued that the issue of central bank independence is not just a juridical issue but rather, it is a practical one.
Demand for Central Bank Independence

Interest in the topic of Central Bank independence has grown significantly over the past few years. From 1989 to the present, over 30 central bank laws were revised, were rewritten, and all in one direction, namely strengthening the independence of the Central Bank. Several reasons underlie the movement towards strengthening Central Bank independence. First, countries that were successful in maintaining low inflation have typically enjoyed better economic performance than countries that were unable to control inflation. Second, the world has undergone a conceptual revolution. In contrast with previous beliefs, the experience of the 1960s and 1970s has revealed that there is no long term trade-off between inflation and unemployment. Accordingly, one cannot produce permanent jobs and accelerate growth on a sustainable basis by creating inflation. Attempts to exploit this trade-off have failed and have resulted in disappointment, frustration, and costly economic distortions. The conceptual revolution has yielded the conclusion that price stability contributes to good economic performance while inflation is a source of instability and economic cost. Third, there has been a fundamental change in the views about the role that governments and economic policy can and should play in the market economy. There is now growing skepticism about the effectiveness of central planning. There is also skepticism about the capacity and the ability of governments to be effective participants in the market place. There is a growing conviction that free enterprise led by the private sector is the best framework within which one can generate investment and sustainable growth. Finally, there is also a growing conviction that in order to promote investment and growth one needs to generate price stability. Thus, the new view about the role of government and the desire to promote sustainable growth within a market economy brought about renewed interest in the conditions necessary for price stability. There have also been four important historical developments that took place in the past few years and that contributed to the growing interest in Central Bank independence. First, the creation of the European Union brought about negotiations on the creation of a new European Central Bank. The Maastricht Treaty specified the key characteristics of the law of the new Central Bank. Accordingly, the Central Bank must be independent, and its main objective must be price stability; the Bank must keep distance from the governments and, thereby, it should be kept free from political pressures, etc.. The European countries that have signed this treaty have adjusted their own Central Bank legislation so as to conform with the provisions of the law of the new European Central Bank. This process heightened the official interest in, and the public's awareness and familiarity with the topic of Central Bank independence. The second development that stimulated interest in the subject was the urgent need to create several new Central Banks due to the collapse of the Soviet Union that brought about the creation of independent Republics. These Republics have realized the need to have a new Central Bank that is independent. The third development arose from the experience of several countries in Latin America that recognized that their suffering from high inflation was associated with having weak, and not sufficiently independent Central Banks. The fourth development has been the emergence of globalized capital markets. More and more countries have realized that in order to succeed in the new highly competitive global environment, countries must be held in high regard by the various rating agencies that grade the economies' risk. These ratings depend heavily on the countries' track record of fighting inflation and on the institutional setting that governs the economic policy making process. Therefore, the conclusion that has emerged is that
a country that wishes to maintain access to the international capital market must aim at achieving price stability and must exhibit a good inflation track record. In addition, it must also have the appropriate institutional and legal framework that underlie the policy making process. Prominent among such institutions is the presence of a independent Central Bank. It is argued that there are incentives that produce an intrinsic bias towards a higher rate of inflation than is socially desirable, and that an independent Central Bank can remove this bias. Following are criteria developed under different heading of independence for a central bank. Political Independence: The central Bank Independence include, among others, Governor not appointed by the government, Governor appointed for more than 5 years; Board members are not appointed by the government; Board members are appointed for than five years; No mandatory participation of government representative in the Board; No government approval of monetary policy is required; Statutory requirement that central bank pursues monetary stability and explicit conflicts with the government is not possible. Economic Independence include, direct credit facility not automatic; direct credit facility - on the market interest rate; direct credit facility- temporary; direct credit facility- limited amount; Central bank does not participate in the primary market for public debt; discount rate set by the central bank and no portfolio constraints and no credit ceiling. Financial Independence includes, Budgetary Independence; salaries of central bank are determined by the central bank; allocation of profit is determined by the central bank; degree of Financial Independence can be assessed considering these variables. Assessment of Independence: Questions those should be examined in assessing central bank independence include about the length of the term of the governor; about the dependence of this term on the timing of changes in governments; does the new government have the power to replace the governor prior to the end of his term; should interest rate decision can be taken by a Board and how many persons should be included in such Board? How many of the Board members should be insiders, how many outsiders? Can the members of the Board earn salaries from other sources? Who determines the budget of the central bank? What happens when there is disagreement between government and the central bank? Who determines the inflation target? Is the bank endowed with all instruments needed for the conduct of monetary policy or does it need to get government approval at each case? In what way and to whom is the bank accountable? Who appoints auditor of the bank and the remuneration thereof? Who authenticates reliability check of FDI figures? and to whom the central bank reports-whether to the ministry of finance, to the president or to the parliament? Bangladesh Bank: The Bangladesh Bank Order of 1972 resembles legacy of former Pakistan Central Order drawn in 1950s. This does not provide any of the practicing independence assessment criteria applicable for an efficient central bank compatible for operation of market economy because of open and hidden political interference since the independence of the country. In the recent time a namesake amendment of central bank order was made by the previous government, which does not indicate any change. The nine member Board include Governor, Deputy Governor-1, 3 GoB officials and 3 GoB nominated persons. The Coordination Council is chaired by the Finance Minister, other members are Commerce Minister, Governor, Finance Secretary, Secretary IRD, and a member of planning commission.
Central Bank Independence Index constructed based on 8 different criteria by Alesina and Grill (1992) on plitical, economic, and 4 criteria by Bade and Parkin Indices of Financial Indpendence (1992) once compared with the Bangladesh Bank Order indicate that these do not meet the qualifying criteria for an independent central bank. Under section 9(3) (d) of Bangladesh Bank Order, the government has the authority to appoint 3 government officials at the Board which is in addition to 4 directors from outside which historically proven to be political appointment. The length of service of governor have been lower than the best practice and those followed in the Asian neighbors. The current governor joined in his job in Feb 2005. During 1972-2007 highest length of service of a governor was 11 years (between 1976-87) while the second highest was 5 years. Four govenors served 4 years each, one 3 years and other served lowest 2 years. Compared to international best practices only one governor completed more than 6 years. Morover, there was no stability on the tenure of govrnor, deputy governor (s) and the director(s) of Bangladesh Bank. Under articles 10(9), 15(1) (a) and 15(1) (b) continuation of the position of governor, deputy governor(s) and director(s) depends on the pleasure of the government i.e practically, on the desire of Finance Ministry and party in power. Moreover, section 10(10) authorised government to grant leave to the governor and deputy governor(s) for any period of time as desired by the Finance Ministry. This arbitry power was misused at several ocasions, by transfering them to other places. This most striking example was the case of deputy governor Mr Ruhul Amin who was granted forced leave on difference opinion with the Finance Minister of last government. Section 9A authorizes Co-ordination Council to coordinate the macro economic framework including fiscal, monetary and exchange rate policy, finalize public sector borrowing which works as hindrance to ensure consistency among marcoeconomic targets. Article 82(2A) states that salary and compensation package of employees would be subject to approval of government which also work as an obstacle on reward, punishment, and employee motivation. Section 65 defines the prodecure of appointing external auditors by the GoB which in other countries are done by the Board and the audit fee of Bangladesh Bank is negligible Tk 0.03m divided between two firms compared to Pakistan Rs 2.5 m and India Rs 4.5m. This indicate the current state of corporate governance within the central bank of Bangladesh. For transparency and corporate governance these provisions needs be deleted from the statute. Time has come now when a truly non-party caretaker government is running the administration of the country who can f rm a Task Force to make recommendation to the government for the Independence of Bangladesh Bank compatiable to promote and facilitate ongoing economic liberalization towards market economy. The Terms of Reference of the proposed committee should atleast cover, examine the central bank charter of 2 from neghoboring, one from Western Europe, one from Eastern Europe and one from Latin America and compare those with that of Bangladesh Bank Order. Recommend, the ways and means to ensure minimum reqiurement of independence criteria to ensure the terms of appointment of governor and deputy governor, restructuring the Board, free from political pressure, redefine the Terms of Reference of of the Board of Directors, and ensure legal operational, economic and financial independence. Professional bodies dealing with economy, business, industry and trade should raise their voice to ensure independence of Bangladesh Bank to facilitate and promote Bangladesh economy from state to market.
DE JURE AUTONOMY AND ACCOUNTABILITY OF LATIN AMERICAN CENTRAL BANKS
Criterion 1. Objective of the central bank
Argentina Single objective is to preserve the value of the currency President, Vice President, and 8 directors appointed for staggered terms by the Executive with the consent of the senate. 6 years no reelection. Mandates exceed the Presidential term of office. Executive at request of a Senate committee and the chamber of Representatives, removes board members for reasons established in central bank law. Prohibition on extending credit or guarantees to the government or other state entities. May purchase treasure paper, within limits, at market prices.
Bolivia Single objective of preserving price stability
2. Appointment and composition of the Board
President and 5 Directors appointed by the President of the Republic form tried approved by Congress (2/3 of members). 6 years for the president of the BCB (exceeds the presidential term of office). Director last 5 years, and each year one is replaced. President of the Republic removes directors based on legal grounds, including executive responsibility determined by the government auditor.
3. Term of office of the Board
Brazil Formulate monetary and credit policy in order to achieve currency stability and economic and social progress for the country 7 directors appointed by the executive with approval of the senate. They are under the National Monetary Council, chaired by the Minister of Finance The term of appointment is not specified in the legislation Removal of directors of the central bank is the prerogative of the Executive, but legislation does not establish grounds for dismissal.
Chile Stability of the currency and functioning of the domestic and external payments 5 directors appointed by the executive and confirmed by the Senate for staggered terms The term of the President of the BCC is 5 years, and 10 years for other directors Removed by the Executive with approval of Senate, for grounds specified in Law, including voting against objectives of the bank and causing significant injury to the country Prohibition on credit to government except in wartime
Colombia Preserve price stability
Minister of Finance (Chair), General Manager of Central Bank (appointed by the Board) and 5 directors appointed for staggered terms by the executive branch. The 6 directors including General Manager of the central bank serve for four years with a renewable term. Executive branch may dismiss, with approval of the Senate, for legal grounds.
4. Dismissal of Board members
5. Credit to government
Can provide credit to government only to deal with liquidity shortages up to one-year maturity. Decision has to be adopted with support of 2/3 of the members of the Board.
Constitutional Prohibition on direct or indirect credit to government exists. The BCB may purchase government paper through open market operations.
May extend credit with the unanimous vote of the Board, and may purchase government paper at market prices.
DE JURE AUTONOMY AND ACCOUNTABILITY OF LATIN AMERICAN CENTRAL BANKS (contd)
Costa Rica Dominican Republic Maintain the domestic and Promote and maintain external stability of the most favorable monetary, currency exchange, and credit conditions for stability and orderly performance of national economy. Regulate Nations monetary and banking systems. President of BCCR and 5 Monetary Board composed members, appointed by of 10 members. Executive Executive, Plus Minister appoints governor and 7 of Finance. The 5 members plus min. of members appointed for Finance and Min. of staggered terms and Industry confirmed by congress According to central bank President of the BCCR law, Governor and 7 has same term than the President of the Republic, members appointed for 3 years (reelected). From a and that of the other 5 subsequent general law members is 90 months. terms are undefined. Supreme Court decides. President of BCCR Governments lawyer removed by Executive accuses based on violations branch at will. Other 5 defined in central banks directors removed for law. causes defined in BCCR law, at request of BCCR Board. May purchase government Implicit prohibition to grant direct credit. Can paper up to 5% of total purchase securities up to budgetary expenditures, 30% of Government re and conduct repo venues. Can provide credit operations on secondary to state banks who can market finance government.
Guatemala Promote the creation and maintenance of monetary, exchange and credit conditions favorable to the orderly development of the economy.
Honduras Maintain internal and external value of domestic currency and favor normal functioning of the payment system.
Mexico Ensure the stability of the currencys purchasing power.
Executive appoints president/ Vice-president, 1 member by congress, 2 by private sector and 1 by University. Also 3 government ministers. Presidents term is the same as the government (4years). University representative 4 years and other 2 for 1 year, renewable By the Executive branch, for grounds established in law.
Executive appoints 5 Directors. Minister of Finance is part of the Board with out decision power. Years simultaneously with government period.
5 members appointed by the president of the Republic with the approval of the Senate.
Governors term is 6 ears and other members 8 years, with an staggered appointment. Decided by the Senate for grounds established in law at the request of a majority of the Board, and after the approval of the Executive. Through open market operations, and temporary overdrafts to pay domestic debts.
The supreme Court suspends Board members as a result of common and official offenses against the law. Direct credit forbidden except under emergency, and to cover seasonal variations of government revenues or expenditures up to 10% of total. Also via secondary market.
Prohibition of direct or indirect financing to government
Nicaragua Stability of domestic currency and normal functioning of domestic and external payments.
Paraguay Preserve price stability and promote effectiveness and stability of financial system.
Peru The purpose of the BCRP is to preserve monetary stability
President appoint by president of the Republic, 4 Members appointed by Executive (including 1 nominated by Congress) and Min of Finance. All directors have 4 years term. President and director nominated by Congress have similar term than Executive. Other 3 appointed at midterm President of the Republic after approval of the rest of the member s of the board CBN can discount directly government paper up to 10% of revenues. Also purchase government securities under OMOs.
President and 4 Directors appointed by the President of the Republic in agreement with the Senate. President term coincides with the constitutional period. Other members are appointed for a 5 year term each in different year. Board members are removed by the Senate for offenses against the law and also because of Poor performance Direct short-run credit up to 10% of projected revenues to cope with seasonal liquidity constraints. Limit is exceeded under emergency.
Executive nominates 4 directors, including the President of the BCRP. Congress ratifies this decision and appoints 3 additional directors. Appointed for the term of office of the President of the Republic.
Uruguay Currency stability, assure functioning of domestic and external payments; ensure adequate levels of international reserves; and promote and maintain soundness, solvency, and operations of financial system. Executive, with the approval of the Senate, appoints the president, Vice president and a director of the BCU. Appointed for the term of office of the President of the Republic.
Venezuela Create and maintain monetary, credit and exchange rate conditions favorable to monetary stability, economic equilibrium and orderly economic development. Executive Nominates the President of BCV (confirmed by Senate) and 6 directors, including a member from the Executive (not Minister of Finace). The President is appointed for 5 years and the directors for 6 years, staggered (except for the Executive delegate).
For grave legal grounds with approval of two thirds of Congress, after allowing director in question to defend himself. Direct financing prohibited. Purchase government paper on the secondary market, up to a limit.
Removal by government with approval of Senate, or after 60 days without it. Grounds: inaptitude, omission or offense in exercise of duties The BCU may purchase and hold government paper for its own account, up to 10 percent of budgetary expenditures.
By the Executive, for legal grounds, including failure to fulfill the obligations of his post. Prohibition on direct financing.
Criterion 6. Lender of last resort
Argentina Only to the extent of foreign currency availability in excess of Convertibility Law. Requirement at below market conditions The BCRA is Specifically exempt from interference in the design and execution of monetary policy. Profits transfer to government after reserves, losses offset from capital and reserves. Government not assure capital integrity. President of BCRA appears before Congress to report on the conduct of monetary, exchange rate and financial policy. Also annual report. Semi-annual financial statements under international standards, certified by external auditor appointed by executive.
7. Independence in use of monetary instruments
Bolivia Liquidity loans at conditions defined by the board of the BCB under absolute majority. Other operations (e.g.,) buy/ discount assets) aimed at preserving stability of financial system. Full independence for the conduct of monetary and exchange rate policies.
8. Financial independence
9. Accountability
Government can increase PCBs capital but is not compelled to maintain capital integrity. BCB profits feed public debt service after increasing legal reserves and capital if required BCB reports periodically to be president of the republic on policies adopted and projected. Annual report presented to Executive and Legislative branches. Financial statements presented to Executive and Legislative branches and to governments audit office. Summary report disclosed in a newspaper.
Brazil In addition to providing credit via a discount window (up to 90 days) and repo lines, the law gives leeway to CMN to regulate assistance to cope with banking crises. BCB has authority to implement resolutions from CMN for policy objectives. Lower rank legislation expands this authority. BCB transfer profits to the Treasury, but government not compelled to maintain BCBs capital.
Chile Liquidity loans up to 90 days, renewable with approval of a Board Majority. Financing for payment of obligations to help bank resolution. Full independence in the conduct of monetary and exchange rate policy. Board may request the government to capitalize the Bank, and the Bank must return profits in excess of capital and reserve requirements The President of the BCC reports to the Executive and the Senate once a year on general rules and policies adopted by the BCC. Income statements are published, including explanatory notes, once a year. This information is externally audited.
Colombia Liquidity loans under conditions approved by the board. No limitations on the amount to be granted.
Independence in the conduct of monetary policy.
Government capitalizes in case of shortfall. Profits are transferred to government after covering legal reserves.
10 Publication of financial statements
Presentation of quarterly and annual reports on monetary policy to Executive and Legislative branches and, recently, on fulfillment of inflation target The BCB Publishes financial statements in accordance with international standards, audited by government institution.
Regular information to the executive and congress.
Financial statements approved by Banking Superintendency. External auditor to central bank appointed by president of the republic. .
7. Independence in use of monetary instruments 8. Financial independence
Costa Rica Emergency loans for up to 6 months (to be renewed at another 6 months) without limits as to amount. Rediscount facilities for up to two months. Independence in the conduct of monetary policy. Profits feed reserves and pay down BCCR debts. Losses not compensated by government.
Dominican Republic Full discretion to provide credit to confront liquidity problems, and during emergency periods that threaten monetary and banking stability. By Constitution mandate, Monetary Board enjoys autonomy to conduct monetary, exchange and credit policies. BCRD does not transfer profits to government. It increases own reserves and losses compensated by such reserves. Government not committed to maintain capital integrity. Allowed to conduct quasi-fiscal operations. Monetary Board compelled to inform Executive when money supply in creases more that 15% in a year publishes annual report and disclose a summary in newspaper. Balance sheets published monthly and annually as part of the annual report.
Guatemala Credits for coping with liquidity and solvency problems, as well as for bank resolution under financial conditions set by Monetary Board. Autonomy in the use of monetary instruments and interest rate management. The law does not required government to maintain capital of the Bank of Guatemala, nor are its profits transferred to the government. Policy related losses recorded as an asset account. Annual report published at May 31 each year. The report is submitted to be Executive but not to Congress. A condensed balance sheet is published each month. Financial statements are published.
Honduras To confront temporary liquidity shortages under conditions defined by the Board up to 1 year maturity. Quantity limited by the amount of good quality assets. Full independence to formulate and conduct monetary, exchange and credit policies. After increasing own reserves, CBNHs profits are transfer to the government. Government is not committed to maintain CBHs capital integrity. Congress approves CBHs budget. The Board reports annually to the Congress and twice a year to the \executive about the CBH activities. Financial statement published with 30 days following end of fiscal year. Balance sheets also published monthly. Superint of Banks supervise. Weal accounting practices.
Mexico No emergency loans but central bank allows overdrafts. LOLR via short term monetary operations. Limitations in the amount are implicit by nature of the operations Autonomy in the use of monetary instruments, but government allowed to participate in exchange rate management. Bank of Mexico preserves real value of its capital and reserves. Beyond this, transfers profits to government after reserves are funded, but government not assures capital integrity. Semi-annual reports to the Executive and Legislative branches on the conduct of monetary policy, and at the beginning of the year on policy planning. Monthly publication of financial statements independent auditor reports to executive and Congress on of financial statements.
9. Accountability
Publication of economic report twice a year. Also a formal annual report, including an analysis of monetary policy performance. Monthly publication of financial statements, signed by BCCRs internal auditor. Losses recorded in monetary stabilization account.
Nicaragua Liquidity support against collateral up to 30 days period. These loans are not permitted if bank has capital deficiencies.
7. Independence in use of monetary instruments
CBN is legally entitled to determine and conduct monetary and exchange policy.
Paraguay Liquidity support up to 90 days maturity under financial condition s determined by Board. Can be renewed if approved by qualified majority. Larger credit support under crises situations. The CBP shares with the Government the formulation of monetary, credit and exchange policy, and is responsible for its execution and development. Profits increase own reserves, which compensate capital in case of losses. Although government is authorized to increase BCP capital, is not committed to maintain capital integrity. BCP informs Executive and Legislative on main economic issues without periodicity. Publishes annual report. Accounting procedures under generally accepted principles. Financial Statements endorse by governments auditor. BCP reports on income statements to Executive and Congress.
Peru Liquidity support against collateral for term of 30 days renewable up to 90 days, to maximum amount. The interest rate is set by the BCRP. Autonomy in the use of monetary instruments and interest rate management.
Uruguay Purchases and discount of paper up to 365 days, under terms set by the Board, but with limitations on the amounts. Advances up to 90 days against guarantee. Autonomy in the use of monetary instruments and interest rate management.
Venezuela Credits up to 60 days, with no limits set on amount or interest rate. In exceptional cases, credits may be extended to 180 days. Provide resources to FOGADE Autonomy in the use of monetary instruments and explicit powers to conduct interest rate policy. Comanagement with government of exchange rate policy. Government replenishes capital as necessary and profits are transferred according to rules established by the Board of Directors. A report on BCV operations is presented to the Executive, the Congress and the public BCV financial statements published twice a year, under regulations issued by the Banking Superintendency.
8. Financial independence
9. Accountability
After feeding own reserves and provisioning, profits are transferred to the government. Government assures CBN capital integrity Annual report presented to president of the Republic and published.
Profits are transferred to government after provisioning legal reserves. Losses are charged to reserves, and any remainder is offset by the government. Publication of an annual report and monthly reports on the principal macroeconomic variables. Financial statements published annually certified by internal auditor, reported to superintend. Of Banks and Comptroller General. Summary versions published monthly.
Monthly disclosure of financial statements. Annually as part of annual report with opinion of external auditors under generally accepted accounting norms.
The Capital of the BCU is defined by law. Profits fund reserves up to twice the real value of capital. Government does not offset losses if reserves are exhausted. Reports sent to government once a year about monetary program and economic performance. Reports submitted to Congress. Financial statements are published annually, after submission to the Executive and the Accountability Tribunal.
References
Alesina, A. and N. Roubini (1997), Political Cycles and the Macroceonomy, Cambridge, Mass., MIT Press. Alesina, A. and R. Gatti (1995) Independent Central Bank: Law Inflation at No Cost?, American Economic Review 85,196-200. al-Nowaihi, A. and P. Levine (1996), Independent but Accountable: Walsh Contracts and the Credibility Problem, CEPR Discussion Paper, No.1387. Bad, R. and M. Parkin (1988), Central Bank Laws and Monetary Policy, mimeo, University of Western Ontario. Barro, R.J. (1995), Inflation and Economic Growth, Bank of England Querterly Bulletin 35,166-76. Barro, R.J. and D.B. Gordon (1983), Rules, Discreation, and Reputation in a Model of Menetary Policy, Journal of Monetary Economics 12, 101-20. Briault, C., Haldane A. and M. King (1997), Independence and Accountability, in:Kuroda, I. (ed.), Towards more effective monetary Policy, St. Martins Press; New York. Campillo, M, and J. A. Miron (1996), Wby Does Inflation Differ Across Countries? NBER Working Paper No. 5540, Cambridgem Mass. Canzoneri, M., V. Grilli, and P R Masson eds., (1992) Establishing a Central Bank : Issues in Europe and Lessons from the U. S. Cambridge: University Press. Cukierman, A., (1992), Central Bank Strategy, Cridand Independence: Theory and Evidence. Cambridge, Mass.: MIT Press. Cukierman, A., Webb, S. B. And B. Neyapti (1992), Measuring the Independence of Central Banks and Its Effect on Policy Outcomes, The World Bank Economic Review 6, 353-9. Debelle, G. And S. Fischer (1994), How Independent Should a Central Bank Be?, in Fuhrer J.C. (ed.), Goals, Guidelines and Constraints Facing Monetary Policymakers, Boston, Federal Reserve Bank of Boston, Conference Series No. 38, 195-221. Eijffinger, S.C. W. And J. De Haan (1996), The Political Economy of Central-Bank Independence, Special Papers in International Economics No.19, Parinceton, New Jersey. Fischer, S. (1995a) Central Bank Independence Revisited, American Economic Review 85, Papers and Proceedings, 201-6. Fischer,S. (1995b), The Unending Search for Monetary Salvation, in: Bernanke, B.S. and J.J. Rotemberg (eds.), NBER Macroeconomics Annual 1995, Cambridge, Mass., 274-86. Fuhrer, J.C. (1997), Cen tral Bank independence and Inflation Targeting; Monetary Policy Paradigms for the Next Millineum?, New England Economic Review , 19-36. Grilli, V., Masciandaro, D. And G. Tabellini (1991), Political and Monetary Institutions and Public Financial Policies in Industrialized Countries, Economic Policy 13, 341-92. Hutchison, M.M. and C.E. Walsh (1997), Central Bank Institutional Design and the Output Cost of Disinflation: Did the 1989 New Zealand Reserve Bank Act Affect the OutputInflation. Illing, G. (1998), Mechanism Design for Central Banks- Results and unsolved Issues, in: Wagner, H. (ed.), Current Issues in Monetary Economics, Berlin, Heidelberg, and New York, Springer- Verlag, 29-54 Jensen, H. (1997), Credibility of Optimal Monetary Delegation, American Economic Review 87,91120. Jordan T.J. (1997), Disinflation Costs, Accelerating Inflation Gains, and Central Bank Independence, Weltwirtschaftliches Archiv 133,1-21. King, M. (1996), Direct Inflation Targets, in: Deutsche Bundesbank (ed.), Monetary Policy Strategies in Europe, Munchen, Verlag Vahlen, 45-74.
Kydland, F. E. And E.C. Prescott (1977), Rules Rather than Discretion: The Inconsistency of Optimal Plans, Journal of Political Economy 85, 473-91. Kydland, F., and E Prescot (1977) Rules Rather than Discretion: The Consistency of Optimal Plans. Journal of Political Economy 85:473-91. Luis I. Jacome H, (2001): Legal Central Bank Independence and Inflation in Latin America : IMF Working Paper, Monetary and Exchange Affairs WP/01/212 Mangano, G. (1997), Measuring Central Bank Independenc: A Tale of Subjectivity and of Its Consequences, Cahiers de recharches economiques 9704, University de Lausanne. McCallum. B.T. (1995), Two Fallacies Concerning Central Bank Independence, American Economic Review 85, Papers and Proceedings, 207-11. Nolan, C. And E. Schaling (1996), Monetary Policy Uncertainty and Central Bank Accountability, Working Paper Series No. 54, Bank of England, London. Posen,A. (1993), Wby Central Bank Independence Does Not Casus Law Inflation: There is No Institutional Fix for Politics, in : OBrien, R. (ed.), Finance and the International Economy 7, Oxford. Schelling, T C (1960) The Strategy of Conflict. Cambridge, Mass:Harvard University Press. Siklos, P.L. (1995), Establishing Central Bank Independence : Recent Experiences in Developing Countries, Journal of international trade & economic development 4, 351-85. Walsh, C.E. (1995d), Central Bank Independence and the Cost of Disinflation in the EC, in Eichengreen,B., Frienden J., and J. Von Hagen (eds.), Monetary and fiscal Policy in an Integrated Europe, Berlin, Heidelberg, and New York, Springer-Verlag, 12-37.

47 Political Economy of Central Bank Independence - Jamal

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Political Economy of Central Bank Independence

What Shapes and What Shakes it?

Box 1: Summary of Best Practices on Central Bank Independence and Accountability

Clarity of Objectives Political autonomy

Criteria (Weight) 1. Central Bank Objective (2)

10. Transparency and disclosure of financial statements (1)

Table 3. Central Bank Independence and Accountability ( Country evaluation)

Bolivia, Brazil, Chile, Dominican Republic, Guatemala, Paraguay, Venezuela

10. Transparency and disclosure of financial statements (1)

Costa Rica, Dominican Republic, Guatemala, Honduras

Structure of Central bank

Alesina and Grill Index (1992)

Bade and Parkin Indices of Political Indpendence

Bade and Parkin Indices of Financial Indpendence

Eijffinger and Schaling Indicator of Central Bank Independence (1993)

Chief Executive Officer

Limitation on lending to government

Indexes Legal Status Opering levels

Appointment of Board Government officials at the Board

Bulgaria Created by Law of Parliament

Parliament and the President

Ministry of Finance and Political Party in power

One member without voting right

Tenure of the Board

initially 8 years now 5 years

Structure of the Board

Governor (1) Vice-Governor (2) Senior Executive members (4)

Indexes Appointment of Governor

Czech Republic President of the Republic

Poland Diet, Senate President

Ministry of Finance and Political regime om power

Allows one member

Indexes Parliament members represntation at the Board Budget Preparation

Demand for Central Bank Independence

DE JURE AUTONOMY AND ACCOUNTABILITY OF LATIN AMERICAN CENTRAL BANKS

Criterion 1. Objective of the central bank

Bolivia Single objective of preserving price stability

2. Appointment and composition of the Board

3. Term of office of the Board

Colombia Preserve price stability

4. Dismissal of Board members

DE JURE AUTONOMY AND ACCOUNTABILITY OF LATIN AMERICAN CENTRAL BANKS (contd)

Criterion 1. Objective of the central bank

2. Appointment and composition of the Board

3. Term of office of the Board

4. Dismissal of Board members

Mexico Ensure the stability of the currencys purchasing power.

Prohibition of direct or indirect financing to government

DE JURE AUTONOMY AND ACCOUNTABILITY OF LATIN AMERICAN CENTRAL BANKS (contd)

Criterion 1. Objective of the central bank

Peru The purpose of the BCRP is to preserve monetary stability

2. Appointment and composition of the Board

3. Term of office of the Board

4. Dismissal of Board members

DE JURE AUTONOMY AND ACCOUNTABILITY OF LATIN AMERICAN CENTRAL BANKS (contd)

Criterion 6. Lender of last resort

7. Independence in use of monetary instruments

Independence in the conduct of monetary policy.

10 Publication of financial statements

Regular information to the executive and congress.

DE JURE AUTONOMY AND ACCOUNTABILITY OF LATIN AMERICAN CENTRAL BANKS (contd)

Criterion 6. Lender of last resort