Central Bank Independence: An Economists’ Idea That Shaped the World? Ryszard Kokoszczyński

Outline Origins of the idea Nice (though implausible) theoretical model Academic solutions Development of theoretical concepts Search for empirical support Changing reality: the case of Poland and the European Union Recent developments: Do central banks engage themselves in fiscal policy?

Problem origins Theory: Empirics: The role of monetary policy; Rules vs discretion debate Empirics: Bundesbank’s experience; Inflation in the late 1960s and the 1970s.

Problem origins II

Theoretical Considerations Theoretical model: time-incosistency of optimal plans (Kydland, Prescott 1977; Barro, Gordon 1983). Solutions: Optimal contract (Walsh); Conservative central banker (Rogoff); Central bank’s reputations; Central bank’s independence.

Theoretical Developments What independence? Goal independence vs. instrument independence Central bank independence and low inflation? Measurement issues Methodological problems Difficult interpretation of results

Correlation between CBI measures and inflation (de Jong 2001)

CBI in Practice Bank of England: „Independent and accountable” – does CBI mean a democracy deficit? EMU central bank – is the EBC the most independent central bank in the world? Central banks in transition economies

European Central Bank Supranational status Strong legal basis (International treaty) EBC and other EU institutions EBC and EU member states

Narodowy Bank Polski (National Bank of Poland) and its road to independence 1982 – autonomous status vis-a-vis Finance Ministry 1989 – new legal framework 1992 – personal independence 1997- NBP’s independence written into the constitution 2003 – financial independence What is lacking: minor legal issues (Governor’s oath, serious misconduct, etc.) NIK (Supreme Board of Control).

Central banks in recent crisis: „unconventional monetary policy”

CBI in danger? With central banks outside the Euro Area now actively engaged in credit easing through the direct acquisition of private securities (commercial paper, corporate bonds, mortgages and ABS) and possibly in the future through unsecured lending to the private sector, the exposure of central banks to credit risk is becoming larger and could become huge in some countries before this crisis is over.  Central banks could therefore be faced, if theysuffer a large capital loss, either to engage in aggressive base money creation to maintain solvency, endangering their inflation targets and price stability mandates, or to go to the nearest Treasury with a begging bowl, thus undermining the central bank’s independence (Willem Buiter, LSE). To protect that independence, the central bank’s lending policies should avoid straying into the realm of allocating credit across firms or sectors of the economy, which I believe is appropriately the purview of the market. If government must intervene in allocating credit, the fiscal authority should do so rather than the central bank. (Charles Plosser, President, Philadelphia Fed)

Theory vs. practice Independence and accountability Optimizing independence: How centralized is the wage bargaining process; Monetary and fiscal policy coordination.

Economic theory can influence reality (though sometimes not in line with economists’ intentions)