CONCEPT – CENTRAL BANK INDEPENDENCE

Excellent study material for all civil services aspirants - begin learning - Kar ke dikhayenge!

CONCEPT – CENTRAL BANK INDEPENDENCE

---

Read more on - Polity | Economy | Schemes | S&T | Environment

---

• The concept: Experts feel that Government control on the central bank generally reduces the efficiency of monetary policy measures. In the 1970s, the industrialized countries faced high inflation and output volatility to a certain extent due to fiscal domination. Therefore, the authorities in the developed countries gradually increased central bank independence in order to increase the impact of monetary policy measures.
• From 1980s onwards: Between the mid 1980s and 2006, inflation and output smoothened in many developed countries, determining specialists to name this  period “The Great Moderation”. It was the result of three important factors: 1) structural changes, 2) better macroeconomic policies and 3) good luck. Consequently, the changes of economic institutions, technology and business practices enhanced economies’ ability to deal with multiple shocks.
• Details: The first central banks were created in Sweden and England and their main task was to finance the budget deficits. The frequent and severe financial crisis, as well as the lack of regulation of the banking system determined the authorities to extend central banks’ objectives in the developed countries. After the two World Wars, central banks dealt with high inflation and unemployment and low output especially in the countries severely affected by the military conflicts.
• Monetary policy conflicts: Specialists realized that there could be trade offs between certain goals established for the central bank, as the monetary authority can not maintain price stability, high economic growths, low unemployment, external equilibrium and a stable exchange rate at the same time. In the 1960s, Friedman stated that the central banks can only influence in the long-run the inflation, the money supply and the exchange rate. Therefore, central banks focused on three main monetary policy strategies.
• The Indian case: In India, the RBI is a government organisation like any other public sector unit. It does not enjoy full power to formulate and conduct a totally independent monetary policy, although the FIT framework seeks to achieve that. The effectiveness of the RBI’s monetary policy is hurt due to the present monetary fiscal link. Such link is established through the government budget constraint which is expressed as G = T+ B + dM where G is government expenditure, B is market borrowing, i.e., borrowing by the Government of India by selling bonds, and dM is increase in money supply caused by government of India borrowing from the RBI.
• Borrowings: As and when a fiscal deficit cannot be covered by additional taxation or market borrowing the government of India is constrained to borrow from the RBI either against accumulated foreign exchange reserves or by issuing T-bills. No doubt the RBI has been imposing strict controls on the member banks so that they cannot lend beyond limits. But the RBI is constrained to make loan to the government of India as and when there is need for monetisation of fiscal deficit.
• Independent central banks: Countries with an independent central bank, such as Germany, Switzerland, and the USA, tended to have low average inflation. Countries that had central banks with less independence, such as New Zealand and Spain, tended to have higher average inflation. Empirical studies have also shown that there is no correlation between central-bank independence and real economic activity (macroeconomic performance). To be more specific, central-bank independence is not correlated with average unemployment, the volatility of unemployment, the average growth of real GDP, or the volatility of real GDP.
• CASE OF THE INDIAN R.B.I.
• The Reserve Bank of India was in the eye of the storm from 2016 onwards. First, it was the demonetisation tsunami. Then, it was the February 12, 2018 circular on NPA recognition. And finally, it was the expectation of monetary easing and surplus transfer. It finally led to the removal (resignation) of Governor Urjit Patel, and his replacement by Shaktikanta Das (earlier in Finance Ministry). Governor Das has toed the expected line of monetary easing, but the economy has slowed down considerably in 2019.

Read more on - Polity | Economy | Schemes | S&T | Environment

Join UPSC Self Prep course | Online Course (PT Gurukul)  | Covid Special Course | Join PT courses

* Content sourced from free internet sources (publications, PIB site, international sites, etc.). Take your own subscriptions. Copyrights acknowledged.