Quasi Independence of Most Central Banks: Implications for Monetary Policy in Advanced Countries and Beyond

Posted: 10 Nov 2016

Date Written: November 8, 2016

Abstract

Around the world, central banks are the gatekeepers of a country’s financial system, ensuring the smooth flow of liquidity across various sectors of the economy where demand for financing projects or business is met with money at a price preferably tuned to the fundamentals of the economy. What is described is the regulatory role of a modern central bank, the most quintessential example of which is the Federal Reserve System of the U.S. But there is also an equally important policy dimension to central banking, the setting of the direction and specifics of monetary policy, the benchmark interest rate, on which other interest rates for banking and housing loan is tied. Economic policy portfolio of most countries can be classified broadly into fiscal and monetary, where the former is the framing of an annual budget for the country through which the government in office aims to implement its economic and policy vision. On the other hand, monetary policy can be better understood as the ballast of the economy, where its adjustment helps modulate possible gyrations in monthly manifestation of economic fundamentals. Specifically, the benchmark interest rate (e.g., federal funds rate in the U.S.) is set through a policy meeting amongst central bankers of the Federal Reserve System banks known as the Federal Open Market Committee meeting. As a guardian of the economy ensuring stable financial health, enforcement of rules set by the legislative assembly together with monitoring of liquidity flows meant that the central bank should be independent. Indeed, the governance structure in most advanced countries have helped ensured that the central bank is “independent” through a system which devolves the government from most decisions on the central bank except for the appointment of its governor or chairman. In advanced economies, the governor of the central bank is confirmed by a public hearing presided by the legislative assembly subcommittee on finance after being nominated for the post by the executive branch of government: usually the Prime Minister or President. Thus, while the candidate is likely to be proficient in banking and an experienced practicing banker able to understand the implications of policy setting, the current structure of nominating the central bank governor points to a possible bias such as pushing forward someone with economic ideas convergent with that of the government and most members of the legislative assembly. Is this possible “group think” desirable from the perspective of tuning a runaway economy on track? Would the governor of the central bank be able to do his job of maintaining financial stability without pressure from the government? Is the current governance structure independent or quasi-independent? And, most importantly, what are the implications for policy setting in the advanced countries that may ripple towards the developing and emerging economies? Interested researchers may want to ponder and expand on these questions in their research.

Keywords: central bank, finance, governance structure, interest rate, monetary policy, fiscal policy

JEL Classification: E50, E58, E60, E63, E66, H10

Suggested Citation

Ng, Wenfa, Quasi Independence of Most Central Banks: Implications for Monetary Policy in Advanced Countries and Beyond (November 8, 2016). Available at SSRN: https://ssrn.com/abstract=2866743

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