Central Bank: Independence
Central bank independence, in particular, has attracted the attention of researchers in this field, who focus attention on de facto and de jure independence. Policy makers who are in senior central bank management sometimes question whether independence can really deliver anything.
Paul Volcker, former Chairman of FED, stressed in the late 1980s that although the Banca d’Italia is a ‘dependent’ central bank, it performed well, even in a country with quite an unstable political situation, that is, government (Volcker, 1989). Thus the central bank, as a part of the public sector, obviously has close contacts with other governmental bodies. Consequently, it is subject to the influence of the government, and particularly its ministry of finance. However, the degree of (in)direct influence can vary significantly (Sevic, 1996c).Initially, the study of central bank independence was carried out through reading central bank statues (laws) rather than through a proper in-depth analysis of policy decision-making and enforcement of rules. North (1993) bluntly admitted that enforcement is a major issue in the process of ensuring one’s credible commitment. Central bank independence, very narrowly understood as independence from the government of the day, became the ‘must’ of the 1990s. Certainly, even countries that did not experience any (significant) inflation, like Italy in 1992, Portugal in 1992, Belgium in 1993, France in 1993, Greece in 1993 and Spain in 1994, decided to delegate their monetary policy formulation to their central banks, making them independent of the executive power (Sevic, 1996d). This trend was continued by Japan, which in the mid-1990s experienced deflation, but decided to opt for central bank independence. Consequently, it is very difficult to prove that high or hyper-inflation is the main motive for promoting central bank independence, as suggested by many neo-classical scholars (see, for instance, Blinder, 1999).
Others, like Maxfield (1997), could not corroborate this conclusion, as it seems that making the central bank independent in developing countries, which can be easily extended to transitional economies, has not yielded any significant economic result. One of the intuitive explanations for this lack of a direct link could be that, in developing countries, discretion rather than rules dominates the political sphere. Informal links and networks are those that influence the actions of the central bank, even if the latter is stricto lege independent. Of course, there are questions of effective and efficient law enforcement and legal systems (as a set of rules) and legal order (as a social behaviour based on prescribed legal rules). In developed countries there is a minor, if not negligible difference between the legal system and legal order, and this may be one of the reasons why many studies in central bank policymaking assumed that the policy-making process is predominantly, if not exclusively, directed by statute (statutory rules). Forder (1996; 2001) documents these trends in great depth. Still the research must begin somewhere, and considering the formal documents may be the first step to initiate further analysis and discussion.Observing the relationship between the government (executive power) and the central bank seems logical, but quite narrow. In the best tradition of law and economics literature and legal research, the relationship between the central bank and all the state powers - legislative, executive and judiciary - must be considered. Legislative power can usually influence the central bank in three ways: (i) through personnel appointments; (ii) through changes in the legal framework (law, act, statute, and so on) and (iii) through a general political monitoring function. The influence on personnel can be seen, alternatively, through three types of relationships. First, the parliament is entrusted by law to appoint a governor, his deputy and/or vice-governor(s), and board of directors.
Second, the parliament approves the appointment of the governor and senior management made by another government body; or third, some members of the parliament are appointed as directors on the central banks’ board. In practice, the parliament usually appoints the governor and board of directors. In countries with a strong presidential influence, the president may be in charge of appointing the governor and directors. However, even in a pure presidential system, such as in the United States, the upper house of the US Congress, the Senate, must approve the appointments. In Cuba there is quite an interesting solution, since there is a shared authority between the National Assembly (parliament) and the State Council (head of state) to appoint the governor upon a mutual proposal made by the president of State Council and the prime minister (Art. 47. Decree-law 84, 1984). A more important influence that the parliament can impose is changing the law. Even in the United States when the Fed failed to show understanding and support for the general political course of the Congress, proposals emerged to change the Federal Reserve Act. Generally, when the central bank enforces a tight monetary policy for a long period of time, without some short-term relaxation, there are incentives to change the law and abolish or reduce the achieved level of (political) independence (Sevic, 1996b). It is stressed by many authors (for example, Rogoff, 1985; Alesina and Tabelini, 1987; Cukierman, 1992; 1994) that the central bank is usually much more concerned with price stability (its ultimate task) than are the political authorities.Finally, the legislative body, as by definition the highest democratic body in the country, is in charge of political monitoring of all institutions within the political system. In this way, the parliament can have particular ‘moral suasion’ influence over the central bank. Public criticism addressed towards the central bank has no legal implications, but can urge the bank’s senior management to reconsider some of their decisions.
In a democratic country the parliament is the most democratically elected body and has particular social prestige and direct responsibility before the electorate. The central bank, as with all the other social institutions with appointed senior personnel, has only a derived, indirect responsibility. Again in the majority of democratic countries, tradition ensures that the central bank is a socially responsible and highly publicly appreciated institution. The early experience of some countries (Britain, Austria, Germany and Serbia; see Kent, 1966) showed that the ‘personal charisma’ of the governor is a very important element, which influences further development. Political supervision is performed through the central bank’s obligation to submit yearly reports for approval to the parliament. Even if the report is to be submitted to the president, it will usually be finally assessed in the parliamentary session. This is the case even in the parliamentary system with a strong president (so-called ‘quasi- presidential system’) as in France. In our view the overall political, that is ‘democratic’, control over the central bank must stay in the hands of the parliament as the most widely elected political body, with overall responsibility for the well-being of the country.The relationship between the central bank and the judiciary has not been widely considered in the theory. Economists have usually seen the central bank as an executive body for the implementation of monetary policy and, in that capacity, subject to the influence of the government. But, given the public nature of the central bank, it is to be expected that the courts may examine decisions of the central bank as they have all the necessary characteristics of an administrative act. There are countries such as Bahrain, where it is clearly stipulated in the law that the legality of central bank acts will be examined by the courts. Another possibility is not to define procedural subjectivity, but to define its special legal position (as in Germany).
The Austrian law on central banks - NBG (Nationalbankgesetz, 1984) - has stipulated the establishment of an ad hoc arbitrage. In the Austrian case, this legal solution granted de facto indirect independence to the National Bank, although it is formally subordinated to the government. The NBG is very detailed in regard to the arbitrage, and regulates all the procedure before it, saying that the rules on civil procedure will be applied analogously. In countries with a continental legal tradition, it should be expected that every central bank legal act resulting from administrative procedure may be subject to examination of legality before the Administrative or High Court.However, theory is usually most interested in the relationship between the central bank and the executive power (government). Comparative analysis of central bank laws has shown that the government can perform some personnel and general supervisory duties over the central bank in the United States. Usually by law, governmental influence can be: (i) personnel and (ii) monitoring (Sevic, 1996b). There is no country where the government has no influence at all over the bank’s appointments at senior level. In some countries the executive power proposes the candidates, while in others it appoints directors of the central bank. It is quite rare for a particular minister to appoint leading officials at the bank, as is the case in Iceland. This is of particular interest since the central bank performs duties as the government’s banker. Researchers try to measure central bank independence in many different ways, but there is a consensus that it is a very complex task since central bank independence is determined by a multitude of legal, institutional, cultural and personal factors which cannot be easily quantified (Cukierman, 1991, 1992, 1994). In the recent literature, attention has been paid to legal independence, the actual turnover of governors and answers by national policy makers to a questionnaire on the behaviour of the central bank in practice.
This complex approach has notably been employed by Cukierman (Cukierman, 1992). Other more ‘classical’ authors paid attention to the institutional features and inflation volatility (Alesina and Summers, 1993; Wood, et al., 1993). In both approaches the authors consider legal proxies, such as the position of law towards issues such as the legally determined mandate in office for the governor and senior management, who appoints them, who can dismiss them and under what circumstances, who prevails in the case of policy conflicts between the central bank and the government, whether the government can issue orders to the central bank, how independent the central bank is from a fiscal point of view, what restrictions are imposed on central bank lending to the government and other entities in the public sector, and so on. Also considered is whether the law requires the central bank to achieve price stability (even at the cost of other real objectives). The empirically based studies have shown that the more independent central banks are better at achieving price stability and vice versa. At the same time, high and long-term inflation erodes central bank independence. Although researchers tend to stick to other, more quantifiable, variables rather than considering legal and institutional framework, it seems that in the end they have to go back to this. The institutional framework affects not only the structure of social entities, but also the way in which they interact (Sevic, 1995).