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Issues in Central Bank Independence


Chris Ehi Nemedia
The question of independence of central bank has to do with the proper relationship between the monetary authority and rest of the governmental authorities of a nation. It has generated continuing controversy in several countries, both developed as well as developing. The central bank is at the apex of the monetary and banking structure of the economy and its functions can be sufficiently differentiated from those of the other financial institutions. The central bank is expected to carry out its functions as best as it can in the national economic interest. Determined or reflected in its major distinguishing functions. For the older central banks in the developed countries these functions evolved over along period of time and have become traditional to them while the newer central banks have been empowered by statue to perform most of them. The major functions include:
Partial monopoly or sole right of note issue which empowers the central bank to regulate the currency in accordance with the requirements of the business and the general public;
General banking and related agency services for the government;
Custody of cash reserves of commercial banks;
Custody and management of the nation’s reserves if international currency;
Bankers’ bank and “lender of last resort” which involves the central bank in the provision of credit facilities in the form rediscounts or collateral advances to commercial banks, discount houses, bill brokers and dealers or other banking institutions;
Settlement of clearing balances between the banks, and the provisions of facilities for the transfer of funds from one important center to another; and
Control of credit in accordance with the needs of business and the economy generally and for the purpose of carrying out and broad monetary policy adopted by the government.
Economists have experienced divergent views as to which of these functions makes a bank central bank. In the interview years (1920s and 1930s) the “lender of last resort” function wasconsidered the core function of central bank (R.G.) Hawtrey(1932) while Vera Smith (1936) regarded the primary function of a central bank as that of complete or residuary monopoly in the note issue. According to W.A Shaw (1930) the characteristic function of a central bank is the control of credit while to Kisch&Ekin “the essential function of a central bank is the maintenance of the stability of the monetary standard” which “involves the control of monetary circulation”. Others even regard clearing as the main operation of central banking L.C Jauncey {1933}. In the statue of the bank for international settlements (B.I.S) a central bank defined as “the bank in any country to which it has been entrusted the duty of regulating the volume of currency and credit in that country”.
However, modern experts have pointed out that it is difficult in practice to select any of the major functions as the characteristics function or even to rank the functions in order of importance since they are interrelated and complementary. The guiding principle for a central bank, no matter the functions it is empowered to perform at any particular point in time, is that of acting only and always in the interest of the public without regard to profit as a primary motivation. Even so, the control of the credit has become the main function of the central bank in all countries of any economic significance. It is this function which embodies the fundamental questions of central bank monetary policy and the one through which embodies the fundamental questions of central bank monetary policy and the one through which practically all “the other factions are united and made to serve a common purpose”.
Thus the issues of central bank independence have come to revolve around the degree of autonomy a central bank should be allowed in formulating and implementing effective monetary policy. The remainder of this paper is in three parts. The controversies surrounding central bank independence are discussed in part II while part III presents a global survey of country experiences, the conclusion flowing from the discourse are carried out in part IV.
Given the fact that the major responsibility for the determination for a nation’s monetary policy rests with its government coupled with the fact that it is the government that empowers the central bank to exercise a monopoly of note issue as well as the general control of credit in the national interest, it is not surprising that all government all over the world have claimed the right to increasing participation in the affairs of the central bank. In general, state participation in the affairs of the central bank has taken the form of sole or partial ownership of the capital, and/or the appointment of all or some of its directors and chief executive officers; and/or a share in its profits. Under those circumstances, in what context should the “independence” of the central bank be premised? Independence of whom and for what purpose?
As mentioned in the introductory section, the question of independence of a central bank has to do with the proper relationship between such a bank as the accredited monetary authority of the nation and the rest of the government agencies. The proponents of central bank independence are not arguing that the central bank should operate independently of the government but that it should function without any subordination toany of the other arms of the government. In support of this view, the advocates of central bank independence argue that;
Monetary management involves highly technical operations and therefore should be handled by independent experts.
Experiences in several developed as well as developing countries strongly indicates the need to allow the “highly important task of monetary management” to be handled partially and effectively by divorcing it from political pressures.
Allowing the executive arm of government to possess power over the creation of money as well as restrain responsibility for fiscal operations involving domestic debt management or borrowing to meet government budgetary deficits poses a considerable danger of reliance on unsound monetary policies because of the tendency to minimize, in the short-run, government borrowing costs at the cost of encouraging inflationary pressures.
Reacting to the argument of those who support central bank independence, several eminent economist have advanced an opposing view as follows: with reference to the U.S economy, J. Gurley (1964) opposed the view that the Federal Reserve System (central bank) “should be independence in order to be able to effectively carry out unpopular anti-inflationary policies without political pressures”because such argument, according to him, implies that central bankcan institute monetary policy because they know best what is good for the people, even when the majority of the people do not want the anti-inflationary stance of central bank’s monetary policy. In the same vein, Dudley Johnson (1964) expressed the view that“…..to argue that the control over money supply should be independent of the values of certain representatives of the citizenry in a democracy, strikes me as ludicrous”.
On his part, H. Scott Gordon (1964) made the following reservations against central bank independence:
“The view that operating independent is desirable springs largely from the fear that the executive branch may be tempted to misuse the great financial powers of the central bank by preventing it to partisan or even personal ends. To my mind, such evils are possible in all spheres of governmental operations and the real guarantee against them is the light of public knowledge. The sphere of finance does not inherently contain greater gangers of this sort than this of, say defense or public works”.
An important factual nationalization of the older central banks in Europe and elsewhere was accompanied by the wider powers of the state control over their policy and operations. The degree of control is far from uniform, and depended largely on each country’s domestic political philosophy or practices as well as the stage of economic development. It is also true as highlighted in some details in part three below, that there has been a pronounced and persistent trend towards the extension of state ownership and control of central banks. In England, India, and the Netherlands for example, provision is made for Treasury direction to the central bank in order to co-odinate the government’s monetary and financial policy with that of the central bank in the interest of the public. In several Asian and Latin American countries, although submitted to the Minister of Finance for approval or prior review.
In attempting to resolve the conflicting views relating to central bank independence a number of experts have cautioned or pointed out that (a) monetary authorities do not have a monopoly or unbiased wisdom and objectivity; (b) monetary policy do not contain special power to affect the economy in ways no other policy weapon can; (c) it may not be appropriate for the monetary managers to attempt to impose their view against the desires of the majority of the populace: and (d) consequently, the case for independence carried to the extreme could become indefensible. They have also stressed that monetary and fiscal policies represents different means of achieving essentially the same ends although monetary policy may appear to be more sensitive to the problem of unemployment. This realization points to the need to ensure effective co-ordination of macroeconomic policy formulation and implementation. The fiscal and monetary authorities should jointly resolve the tradeoff between conflicting policy environments in order to avoid working at cross-purposes and negating the attainment of each other’s policy objective.
The relationship between the central bank and the other relevant arms of government which is institutionalized in a formal arrangement that best ensure the best ensure the effective co-ordination of macroeconomic policies should reflect a relationship of mutual independence within the government. In the U.S. for instance, the chairman treasury meet at least weekly to co-ordinate policy while the President periodically confers with the Chairman of Federal Reserve Board of Governors to minimize conflict of objectives.
The Federal Reserve System which constitutes the central bank of the United States of America possess a unique degree of insularityfrom both the executive and the legislative arms of the U.S Government. The members of Board of Governors, once appointed, serve fourteen-year, nonrenewable term. A President who is displeased with a Board member may not remove him from office or can be elicit obedience to his views by a promise of reappointment.Similarly, the system instrument of legislative form congregational appropriation which is one of the most potentinstrumentof legislative control. It earns its own income and therefore has no need to appear annually before Congress to request for funds. It should be observed however, that the FederalReserveSystem is not completely independent of the legislature. It is created by Act of Congress and therefore can be changed or abolished at its pleasure. It does however, possesses a degreeof independence within the Government that is unique.
An amendment to the statue of the central bank of Germany, the Bundesbank in 1957 requires it to support the general economic policy of the Government in carrying out its duty of safeguarding the value of its currency. It however state that the Bank is independent of government direction in the exercise of its legal powers. There is also a provision that requires the Bank and the German Government to consult each other on important matters of monetary policy. The members of the Government were also empowered to participate in the deliberations of the central bank council and to submit proposals but they did not have the right to vote and could only delay a decision of the council for up to two weeks.
The position of Bank of England may be described as that of a semi-independent statue which nationalized it made provision to the effect that “the Treasury may from time to time give such directions to the bank as after consultation with the Governor of the bank, they think necessary in the public interest”. The board of Governors if appointed by the Government but charged with the responsibility for the overall policy direction of the Bank.
In Japan, although the Government only partially nationalized the central bank (Bank of Japan) with the acquisition of 55 percent of its share capital, all the Directors of the policy Board are appointed by the Japanese Government. The Ministry of Finance appoints a representative to the Board with no voting right.
In the Netherlands, the Ministry of Finance is empowered to give direction to the central bank “in order to co-ordinate the government’s monetary and financial policy and that of the bank”. The Bank is authorized to appeal to the crown in the event of disagreement with such directions.
In spite of the complete nationalization of the central bank of Canada (Bank of Canada) in 1938, it is allowed to retain a semi-independent status. In introducing the bill, the Minister of Finance reportedly gave a reason for nationalizing the Bank, the fact that there had been a lot of political controversy with respect to monetary policy in general and the constitution of the central bank in particular. He therefor argued that it was “highly undesirable and very much against the national interest there should be continued political bickering concerning the constitution of the Bank itself”. The Board of Directors is appointed by the Minister of Finance with cabinet approval. The Deputy Minister of Finance is member of the Board while the Governor and the Deputy Governor are nominated by the Board with the approval of the Canadian Government.
In the partial nationalization of the central Bank of Belgium in 1948, the Government made the following explanation: “while not desiring the nationalization of the Bank issue, and without working the Governor of the Bank a functionary dependent on the Minister of Finance, it was felt necessary still further to ensure both the complete independence of the National Bank visa-vis private interest and its collaboration in the general policy of the public authorities”. This has been described as a half-hearted comprise against political pressure similar to what happened in the case of the nationalism of the Bank of England and the Netherland Bank.
There are various interesting cases which the outcome of nationalization of central bank was either a more or less formal subordination of the central banks to the government or at least a substantial decline in the status of the banks in monetary and banking matters relative to that of the treasury. In the communist states of Europe such as Russia, the Government was empowered to direct monetary implementation. Also in several countries in Asia and Latin America, although central banks were accorded separate status, their monetary policy was required by law to be submitted to the Minister of Finance, as the Chairman of the monetary board of the Bank of Korea, is empowered by the Amendment Act of 1962 to request for a reconsideration of resolution adopted by the Board, and if a resolution is over-ruled by a two-third majority of the Board, Government takes the final decision.
In Mexico where the government holds only 51 percent of the share capital of the central bank, the Secretary (Minister) of Finance and Credit has Authority to veto any resolutions of the Council of Administration (i.e. Board of Directors) of the Bank concerning monetary and foreign exchange policy.
In Argentina and several other Latin-American Countries, the Minister of Finance (the Secretary of Treasury) is the chairman of the member of controlling Board of the central bank. All members of the monetary board (Board of Directors) are appointed by the Government through either the head of state or the cabinet (Council of Ministers).
At itsNationlisation in 1936, it was provided that the Reserve Bank of New Zealand shall “give effect as far as may be to the monetary policy of the government as communicated to it from time to time by Minister of Finance”. In 1939, an amendment provided for the Governor and Board of Directors to give consideration to any representations that may be made by the Minister of Finance in respect of any function or business of the Reserve Bank and give effect to any decision of the government relation thereto as conveyed to the Governor in writing by the Minister of Finance. Subsequent amendments to the central bank status in 1950, 1960 and 1964 were made to ensure that “the Bank was to give effect not only to the monetary policy of the government as communicated to it in writing, from time to time by Minister of Finance in accordance with the definition of broad monetary policy contained in the act , but also to any resolution of parliament in relation to that monetary policy” .
A provision in the 1945 act of the commonwealth bank of Australia required the bank to inform the treasury (minister of finance) of its monetary and banking policy and where there is disagreement between them , the treasury may inform the bank that “ the Government accepts responsibility for the adoption by the bank of a policy in accordance with the opinion of the Government ”, and that “ the bank shall then give effect to that policy” . An amendment in 1951 streamlined this position further to the effect that in the event of a treasury- bank disagreement on any matter 0f monetary and banking policy , the Government would still determine the policy to be followed by the bank . However, the treasury was henceforth required to lay before parliament a copy of the Government and the bank concerning the matter in respect of which the difference of opinion arose . When in 1959, the bank was split up , the reserve bank which became the central bank had similar provision retained in its statute to deal with any fundamental difference of opinion between the treasury and the central bank . the major consideration is whether the monetary and banking policy of the bank was“directed to the greatest advantage of the people of Australia’’as prescribed in its statute , namely the stability of the currency , the maintenance of full employment and the economic prosperity and welfare of the people .
The central bank ordinance of 1958 gave the central bank of Nigeria (CBN) the statutory function of note issue, maintenance of external reserves in order to safeguard the internal value of the currency, promotion of monetary stability and sound domestic financial stability and sound domestic financial structure . others are to act as banker and financial adviser to the federal Government and to perform the others traditional function of bankers’ bank and lender of last resort to the commercial banks . the authority to manage and administer the affairs and business of the bank was vested in the board of Director appointed by the Government and chaired by the Governor of the bank.
To facilitate its performance, particularly with respect to monetary policy formulation and implementation, the central bank of Nigeria was as well equipped with an array of instruments which included those of the older central banks (the traditional tools) as well as the new ones which were better attuned to the economic and financial conditions prevailing in its environment. Thus the Nigerian central bank should be said to have been accorded the status of an independent central bank not of the Federal Government, but within it.
Several amendments to the bank’s enabling Act beginning in 1968 have fundamentally altered the relationship between the central bank ad the government in such as way to whittle down its independent and subordinate it to the arms of the governmental machinery such as the treasury (Ministry of Finance) and the Presidency. The 1968 amendment (i.e. section 3 of CBN Amendment Decree No. 3) made the following provisions on direction as to policy.
The board shall keep the Commissioner (Minister of Finance) informed of the monetary and the banking policy pursued or intended to be pursued by the central bank.
The commissioner shall from time to time, if he disagrees with the board on the monetary and banking policy pursued or intended to be pursued by the central bank, so informa the board of his disagreement thereto, and the commissioner ma submit his representation and that of the central bank on the disagreement to the Federal Executive Council.
The Fedral Executive may in writing after considering the representations, direct the Central bank as to the monetary and banking policy pursued or intended to be pursued and the directive shall be binding on the board which shall forthwith take all steps necessary or expedient to give effect thereto.
In a further amendment in Decree 24 of 1991, the President was substituted for the Minister and the Federal Executive Council as the sole authority for the final determination or approval of the monetary and banking policy to be pursued or implemented by the Central Bank. The same agreement also gave the authority for appointing the Governor and the Deputy Governors of the Bank to the President for a renewable term of five years i.e. they serve a the pleasure of the President. The subordination of the Central Bank of Nigeria to the arms of Government was carried yet to another step further in 1995 by Decree 17 (Monitoring and Miscellaneous Provision Decree) which required the Central Bank to seek the approval of the Minister of Finance for the guidelines it may issue from time to time to regulate the procedures for transactions in the foreign exchange market for such other matters as may be deemed appropriate for the effective operations of the market. The Decree (Act) also empowered the Minister to intervene in the foreign exchange market by the provision which states that “the Minister may, from time to time, issue such directives not inconsistent with this decree for the efficient operation of the market”.
With effect from January, 1997, a further amendment to CBN statute was affected to bring the Central Bank under the supervision of the Federal Ministry of Finance which implies the bank should report to the Head of State through the Minister of Finance and in the event a “serious disagreement on monetary policy between the Ministry of Finance and the Bank, the letter would convey such disagreement to the Head of State through the Minister of Finance and the decision of the Head of State on such matters will be final”. In addition, the bank will now have a board of directors with a part-time chairman i.e. the Bank will no longer be chaired by the Governor, the Director General of the Ministry of Finance and the Managing Director of the Nigeria Deposit Insurance Company are to be members of the Board in addition to three Deputy Governors and four part-time members, all appointed by the Head of State.
The extensive survey of central bank constitutions and administration undertaken in the preceding section indicates ownership and control of central banks all over the world. The initial impetus which is traceable to the 1930s and the 1940s derived from a number of abnormal factors which include;
The World-wide disruptive effects of the Great Depression of 1930-3.
The universal abandonment of the gold standard and the consequent greater scope and need for monetary management which involved governments in taking direct or ultimate responsibility for the monetary policy implemented by their central banks.
The widespread adoption of a deliberate policy of cheap money as an anti-deflationary or reflationary measure in the 1930s and subsequently as a cheap means of financing the war and post-war reconstruction.
The extension of general Government control and intervention in monetary management during the war for obvious reasons, and
The marked trend of opinion toward socialism and the “ welfare state” and consequently towards direct Government control of monetary policy as a means of ensuring full employment and social security.
The movement towards direct government control of monetary policy has manifested in varying forms and degrees in different countries and resulted in varying degrees of independence or subordination in the relationship between the central bank and other arms of the government, especially the Treasury. It has also been observed that even where there is central bank independence, the tendency has been towards less freedom of action and more subordination to the goals of the government and the general economic policy pursued at any point in time.
Governments have generally been compelled to take a more active participation in the formulation of internal and external monetary policy, not only in view of the increasingly important role which they have come to play in financial economic matters, but also as a result of the more general awareness of the effects of monetary policy on both the internal and the external sectors of the economy.
The foregoing should not lead on to rush into the conclusion that the battle for independence has been lost by the central bank. The fundamental question regarding the appropriate status of a central bank or the degree of autonomy which it should enjoy either by legislative provision or the attitude of the other government agencies or both, remains of critical importance in forging the relationship between the central bank and the government or any modern country at any point in time. The need to ensure its accountability precludes the central bank from being accorded a status that makes it independent of the government. However, there are convincing and compelling reasons that the central bank enjoys a position of “semi-independence” or “independence within government”. National economic interest demands a regular and whole-hearted co-operation and consultation between the central bank and the government (especially, the Treasury and other related agencies of the government) to ensure the effective performance of specialized functions and duties of the central bank. It cannot be over-emphasized that the central bank which as the machinery and the expertise to carry out the task of monetary management should be placed in a position to do so effectively and should in no way be hindered from giving independent and objective advice to the government.
There is no doubt that the argument for central bank independent and objective advice to the government.
There is no doubt that the argument for central bank independence as defined above is gaining increasing number of adherents. For instance, the Treaty of Maastricht which created the European Monetary Union (EMU) requires member Governments that wish to join the Union to grant independence to their central banks. the relative independence of the central banks which ensures its insulation from undue political pressure should, all things being equal, bring about a better macroeconomic management performance in general and a greater internal and external confidence in the currency and credit system of the country, in particular.

M.H De Kock: Central Bank, 4th Edition (Universal Blockstall 5 Ansari Road, New Delhi) Chapters 1, 8 & 15.
Central Bank of Nigeria: Twenty Years of Central Banking in Nigeria Chapters 2 & 9.
Harry D. Hutchinson: Money, Banking and United States Economy (Meredith Publishing Company, New York) Chapters 3 & 10 (pp 419 – 426)
Chief S.B. Falegan: General Perspective (Central Bank of Nigeria, Economic and Financial Review, Vol. 33 No. 4, December 1995).
Central Bank of Nigeria, Research Department of Issues in Central Bank Autonomy (CBN Briefs 1996 Series)
Central Bank of Nigeria: 1997 Budget Speech by the Head of State and Budget briefing by the Minister of Finance.
R.G Hawtrey: Art of Central Banking (Cass, 1932), P. 131
Vera Smith: Rationale of Central Banking, (P.S. King & Sons, 1936) P 148.
W.A. Shaw: Theory and Principles of Central Banking, (Pitman, 1930) PP 78 – 80
L.C. Jauncey: Australia’s Government Bank (Cranley& Day 1933) PP 166.
J.G. Gurley: “Testimony before the House Banking and Currency Committee Hearing (Federal Reserve System After fifty years)” Jan – Feb. 1964 P1310

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