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Independence has been granted to central banks in order to shield them from short-

term political influence when fulfilling their mandate of ensuring price stability. It is
largely undisputed that an independent central bank with a clearly defined mandate
is better able to keep inflation lower and more stable.

In the post financial crisis era, however, central banks in many countries have been
entrusted with powers and responsibilities, are going beyond their traditional
monetary policy mandates. Central banks have started acting in the areas of macro-
and micro-prudential supervision and crisis management. Also, while remaining
within their monetary policy mandate, some central banks adopted unconventional
monetary policy measures. Central banks have been over-stretching their mandates,
blurring or even crossing the line into fiscal and economic policy. Central banks are
accused of influencing the distribution of income and wealth and subsidising the
financial sector at the expense of society as a whole – policy areas which
traditionally require more democratic legitimacy and control. This has re-opened the
debate surrounding the legitimacy, and the precise scope, of central bank regulation.

How should the engagement of the Central Banks be regulated?

A central bank or monetary authority is an institution that manages a state's currency,


money supply, and interest rates. Most central banks usually also have supervisory
and regulatory powers to ensure the solvency of member institutions, prevent bank
runs, and prevent reckless or fraudulent behaviour by member banks.

Functions of a central bank may include:


 implementing monetary policies.
 setting the official interest rate – used to manage both inflation and the country's
exchange rate – and ensuring that this rate takes effect via a variety of policy
mechanisms
 controlling the nation's entire money supply
 the Government's banker and the bankers' bank ("lender of last resort")
 managing the country's foreign exchange and gold reserves and the
Government's stock register
 regulating and supervising the banking industry

Central banks play a crucial role in ensuring economic and financial stability within a
country. They conduct monetary policy to achieve low and stable inflation. Since the
late 1980s, inflation targeting has emerged as the leading framework for monetary
policy. Central banks in Canada, the euro area, the United Kingdom, New Zealand,
and elsewhere have introduced an explicit inflation target. Many low-income countries
are also making a transition from targeting a monetary aggregate to an inflation
targeting framework.

Central bank independence is widely accepted as a necessary prerequisite for


successful monetary policies. But considering political sentiment these days, along
with the decline in inflation over the past few decades, there is a chance that this
independence could come into question. Following the global financial crisis, central
banks in advanced economies eased monetary policy by reducing interest rates until
short-term rates came close to zero, which limited the option to cut policy rates further
(i.e., conventional monetary options). With the danger of deflation rising, central banks
undertook unconventional monetary policies, including buying bonds (especially in the
United States, the United Kingdom, the euro area, and Japan) with the aim of further
lowering long term rates and loosening monetary conditions. Some central banks even
took short-term rates below zero.

Considering the May 2016 thought leadership piece by PIMCO Global Economic
Advisor Joachim Fels, “The Downside of Central Bank Independence,” which argued
that independent bankers ran amok with “second-best interventions such as
quantitative easing (QE) or negative interest rate policy (NIRP), which distort financial
markets and can have severe distributive consequences. Also, examining the March
2016 proposal by Joseph T. Salerno, professor of economics at Pace University in
New York, called “A Modest Proposal to End Fed Independence.” Salerno pointed out
“a number of benefits of stripping the Fed of its quasi-independent status and
transforming it into a handmaiden of the Treasury.”

The global financial crisis showed that countries need to contain risks to the financial
system as a whole with dedicated financial policies.

How should the engagement of the Central Banks be regulated?

The engagement of Central Bank be should be regulated by effective frameworks with


close relationship with third party autonomous institution such as IMF as follows :

There must be multilateral surveillance and policy papers to help improve global
outcomes by consulting on policy advice on how to avoid potential side effects from
the implementation of and exit from unconventional monetary policy.

There must be regular dialogue as part of bilateral surveillance. They should work
together on monetary policy action to achieve low and stable inflation, as well as on
establishing effective monetary policy and macroprudential policy frameworks.

There should be Financial Sector Assessment Program to provide an evaluation of


their financial systems and in-depth advice on policy frameworks to contain and
manage financial stability risks, including the macroprudential policy framework.

Independence from government and the political process is obviously helpful when
the main enemy is high inflation, as it enhances a central bank’s credibility and helps
monetary policy makers do tough things without political interference. One example is
the “Paul Volcker recession” of the early 1980s, which was necessary to end the Great
Inflation.

But what happens when the main enemy is not inflation, but deflation, debt overhangs
and financial crises - in other words, the world since 2008?
Critics point out how the need or desire to defend their independence often hinders
central banks from swiftly addressing these problems in the most direct and effective
way (say, helicopter money or overt lender-of-last-resort action to underwrite troubled
financial institutions or sovereigns).

Instead, independent central banks have had to deploy second-best interventions


such as quantitative easing (QE) or negative interest rate policy (NIRP), which distort
financial markets and can have severe distributive consequences. This actually has
exposed central banks to severe criticism on two fronts — criticism of the second-best
policies with their unforeseen effects and diminishing returns, and criticism for making
decisions that the observers say belong in the hands of elected officials.
The main rationale for making central banks independent was to enhance the
credibility of inflation-targeting monetary policy, which became the standard approach
to monetary policy after the demise of the gold standard and the ensuing Great
Inflation of the 1970s and early 1980s. High and volatile inflation had become the
economy’s main enemy, and the solution was to focus monetary policy exclusively on
stabilizing inflation at low levels, with independence making that task easier to achieve.

The main problems today are continuing disinflationary or even deflationary global
forces, public and private sector debt overhangs and the potential for new financial
crises. Central banks would be better equipped to counter the challenges in today’s
economy if they worked in close collaboration with and under the control of a
democratically legitimized government.

One argument for direct government involvement and responsibility is that many of
the decisions that are required to address today’s greatest problems have significant
distributive consequences and are thus in the realm of fiscal policy rather than
monetary policy. Think of the decision to save one major financial institution or let
another one go bust. Think of the decision to serve as lender of last resort to weak
sovereigns (several names spring to mind from the more recent eurozone crisis). Or
think of the decision to buy large amounts of public and/or private sector assets and
introduce negative interest rates to (try to) bring inflation back up to target. All of these
decisions are tough ones to make for an independent central bank that, if it decides to
make them, will be harshly criticized by those who lose out in the redistribution that
follows.

https://www.marketwatch.com/story/what-if-central-banks-were-no-longer-
independent-2016-05-19

Critics of Central Banks


Consider the May 2016 thought leadership piece by PIMCO Global Economic Advisor
Joachim Fels, “The Downside of Central Bank Independence,” which argued that
independent bankers ran amok with “second-best interventions such as quantitative
easing (QE) or negative interest rate policy (NIRP), which distort financial markets and
can have severe distributive consequences. Also, examine the March 2016 proposal
by Joseph T. Salerno, professor of economics at Pace University in New York, called
“A Modest Proposal to End Fed Independence.” Salerno pointed out “a number of
benefits of stripping the Fed of its quasi-independent status and transforming it into a
handmaiden of the Treasury.”

Why Central Banks Are Independent


Historically, governments do not responsibly handle the duty of conducting monetary
policy. The most infamous modern cases, Argentina, Hungary, Zimbabwe and pre-
WWII Germany, ended in brutal hyperinflation. This is because it is tempting for
governments to explode beyond their own budget constraints or for politicians to enrich
themselves at the expense of their citizens' purchasing power. In short, the Fed
theoretically needs independence to make neutral, politics-free monetary policy
decisions without direct political pressures.

For these reasons and several more, most serious policy analysts of the 20th century
considered independence a prerequisite for any effective central bank. Calls for reform
have only come after the recent and disastrous failures of contemporary central banks,
especially the big three: The Federal Reserve, European Central Bank (ECB) and
Bank of Japan (BOJ).

Failures of Central Banking


The Fed has had difficulty on two fronts. First there was the massive data leak by
Goldman Sachs Group (NYSE: GS). Former managing director Joseph Jiampietro
allegedly obtained and shared confidential Fed information to win new contracts, a
move that eventually forced Goldman to pay $36.3 million in a settlement. This episode
followed a $50 million settlement in October 2015 when a different Goldman employee
obtained 35 confidential Fed documents.

The second issue is performance. As Mohamed El-Erian wrote for Bloomberg in June
2016, "unconventional central bank policies are overstretched and near exhaustion."
More than a half-decade of desperate asset purchases and interest rate reductions by
central banks left the world with unprecedented debt loads, over-inflated asset
markets and rising inequality. The great concern of unchecked government control
over the money supply, namely unchecked expansion based on economically dubious
experiments, is now official policy for independent central banks.

Calls for Reform


The loudest critics of Fed independence have been House Republicans, particularly
those on the Financial Services Committee. In February 2015, Committee Chair Jeb
Hensarling (R – TX) opened a hearing by telling Fed Chairwoman Janet Yellen he
doubted the Fed’s efficacy and excoriated the central bank for a lack of transparency
and accountability. “Fed reform is coming,” Hensarling told Yellen. In July 2016, the
Republican party announced that its platform for the 2016 elections will include
“advance legislation that brings transparency and accountability to the Federal
Reserve.”

Yellen, as with former Chairman Ben Bernanke, has maintained a public profile during
her tenure in an effort to appear more transparent. She regularly meets with the White
House and Congress, and often gives policy speeches and holds press conferences
to highlight Fed activity.

What a New Central Bank Could Look Like


Opinions are shifting quickly. As recently as April 2014, the International Monetary
Fund (IMF) held a conference on “Rethinking Macro Policy,” from which the general
consensus was “central banks should retain full independence with respect to
traditional monetary policy.” By August 2015, the World Economic Forum openly
questioned central bank independence and argued that policymakers should go
beyond the taboo of coordinating fiscal and monetary policies.

Dr. Salerno recommends a more transparent and limited process controlled by


administrative orders between treasury departments and central banks, stealing away
the moral hazard of the lender of last resort and ridding central banks of their
coordination with huge financial corporations. Voters would exercise much greater
control over the political fortunes of such a process. Mr. Fels shares similar
sentiments, contending that it would make more sense if central banks worked in close
collaboration with governments and under the control of the democratic process.

Read more: Should Central Banks Be Independent? | Investopedia


https://www.investopedia.com/articles/insights/082416/should-central-banks-be-
independent.asp#ixzz54i8ih0u2
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https://www.bloomberg.com/view/articles/2017-08-07/maybe-central-banks-are-too-
independent

(source courtesy : https://en.wikipedia.org/wiki/Central_bank)

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