An address by Francois Groepe,
Deputy Governor of the South African Reserve Bank,
at the 60th anniversary celebration of the Bank of Ghana
Accra, Ghana
18 August 2017
The changing role of the central bank in economic policy
Governor Addison, distinguished guests, ladies and gentlemen.
It is a great honour for me to address you on this auspicious occasion. Thank you
for the invitation.
The Bank of Ghana has been operating for 60 years. Much has changed over this
period in terms of its role and operations. This is not surprising, as the historical
backdrop in which central banks have had to operate has kept changing over the
decades.
Central banks in the developing world often play a vital role in economic
policymaking, but that role tends to change as the economy and financial markets
develop and new institutional capacity evolves. This is true of many African central
banks. Similarly, in the advanced economies, the role and even mandates of central
banks have come under intense scrutiny and challenge, and many have found
themselves with broader mandates and a wider scope of responsibilities in the wake
of the most recent global financial crisis.
Numerous roles have been assigned to central banks over the years, many of which
do not have to be performed exclusively by these institutions and could also be
carried out by others. Apart from supporting state financing during times of crisis,
two main functional roles have traditionally been at the heart of central banking:
maintaining price stability (subject to the monetary regime) and maintaining financial
stability. This includes crisis prevention and management and resolution as well as
the promotion of financial development in the economy. How these roles have been
interpreted and implemented and their relative emphasis, however, has continued
to evolve over time in response to changing circumstances.
Today, central banks have many other functions, some of which have also evolved
over time. In South Africa, apart from the price stability and financial stability
objectives, the responsibilities of the central bank include the printing of physical
notes and coin, the regulation and supervision of the banking system, ensuring the
effective functioning of the national payment system, and managing the foreign
exchange reserves of the country.
However, in the African context, central banks have had to take on other roles as
well. This is partly due to a relative scarcity of skills and other resources in the
context of pressing developmental needs. In some African countries, central banks
have an explicit developmental role. In Nigeria, for example, the central bank plays
a significant role in providing finance to the agricultural sector. How multiple
developmental needs are dealt with differs from country to country. As is often the
case when it comes to policy prescription, there is no 'one size fits all' solution.
In my remarks to you today, I give you a perspective of how South Africa has dealt
with changing demands and circumstances, particularly since the global financial
crisis.
The South African Reserve Bank (SARB) has been confined to a relatively narrow
and traditional mandate. We do not play a central role in development issues, as
there are specialised institutions for these purposes. The Land and Agricultural
Development Bank of South Africa, as its name suggests, provides financing and
technical assistance to the farming community. The Industrial Development
Corporation provides loans to facilitate industrial development. The Development
Bank of Southern Africa specialises in funding for infrastructure expenditure in
Southern Africa. There are also a number of institutions that specialise in the
financing and promotion of small businesses.
Why does the SARB not engage in developmental activities beyond those
traditionally in the ambit of central banking? The short answer is: because South
Africa has institutions that are better equipped to do so than us. There is no reason
for these activities to be conducted by central banks. By the same token, there is no
reason why central banks should not undertake such activities if resources and
capacity are limited in the rest of the economy. It should, however, be remembered
that central banks are not elected and hence it is preferred that their mandates are
specific and narrowly defined.
There should also be a clear delineation between the balance sheets of these
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different activities of central banks to avoid any conflicts of policy objectives, but
also to ensure that these activities are not financed through direct loans from the
central bank, i.e. through money creation. Under these circumstances, the role of
the central bank would generally be to disburse funds that are raised in the capital
markets at competitive rates, or that are funded by grants from government and/or
multilateral organisations. There is no inherent reason why the central bank would
have the advantage of assessing the needs of these sectors relative to the
specialised institutions that would have the necessary expertise to do so. Having
separate institutions helps to avoid conflicts over resources within the central bank
and reduces the possibility of the politicisation of monetary policy, which could
ultimately undermine central bank independence.
The conduct of monetary policy changed markedly during the 1980s, in line with
global developments. Price stability became an important focus, particularly
following the emergence of inflation that followed the collapse of the Bretton Woods
era and the 1973 oil crisis. During this period, there was a general move away from
direct controls and quantitative restrictions and ceilings to the targeting of monetary
aggregates in the context of more liberalised financial markets. Interest rates
became the main instrument of monetary policy, and during the 1990s the trend
moved away from a focus on intermediate targets to targeting inflation directly.
In 2000, South Africa adopted an inflation-targeting framework, with government
and the SARB agreeing on a target range of 3-6%. Similar developments were
evident in many other African countries, including in Ghana, which adopted inflation
targeting in 2011. While the operational framework had changed, the underlying
objective of price stability did not.
the SARB's primary mandate written into the country's new
During the 1990s, was
Constitution. This mandate was and remains the protection of the value of the
currency in the interest of balanced and sustainable economic growth in the country.
We are given constitutionally entrenched independence in carrying out this
objective. This approach is not very different from that of the Bank of Ghana, whose
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'monetary policy objective is to ensure price stability low inflation and, subject to
economic
that, to support the government's objectives, including those for growth
and employment'.1
Having a price stability objective does not, however, necessarily resolve the debates
about the broader role of monetary policy in the economy or reduce the pressure on
central banks to play a more prominent role in stimulating growth. As a flexible
inflation-targeting central bank, we do not ignore growth or employment. In carrying
out our price stability mandate, we have always been highly sensitive to the growth
needs of the economy and to the implications of our policies for growth. Ideally, we
would try to conduct a contracyclical monetary policy: tightening policy when the
economy is overheating with inflationary pressures evident, and providing some
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stimulus or accommodation when the economy is in a downturn and when
inflationary pressures are benign.
This approach is, of course, standard textbook prescription. Admittedly, we have
faced a number of challenges, not least of which is the fact that the breaches of our
target range have generally been the result of supply-side pressures, including
international oil prices, food prices, and the exchange rate of the rand. These
exogenous forces have at times pushed us in the direction of procyclical monetary
policy. Although we do try to look through the first-round effects of these pressures
and only react to the emergence of second-round effects, our objectives are at times
1
Bank of Ghana website (https://www.bog.gov.gh/)
criticised for not being sufficiently pro-growth. Furthermore, in times of very slow
growth, as is currently the case in South Africa, there are those who see monetary
policy as a solution to the growth problem, despite the fact that monetary policy has
a very limited ability to change the long term growth potential of an economy.
While we see some role for monetary policy in a cyclical context, we view our main
contribution to growth as being in the provision of a stable and enabling environment
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for investment and employment creation through maintaining price stability. Price
stability also has other important social outcomes, not least of which is the protection
of the poorest in society from the ravages of inflation. The poor are the least able to
hedge against price increases. However, we are very clear that monetary policy has
a limited role to play in addressing structural growth problems in an economy. In
other words, monetary policy has a limited impact on potential output. This is the
role of other policies.
The decade from the mid-1990s was a period of widespread adoption of inflation
targeting in the advanced economies and in a number of emerging market
economies. It was also the period of the 'great moderation', which some analysts
interpreted as the end of the business cycle. Asset markets were booming and
global inflation was low, as were interest rates. In fact, in the early part of the 2000s,
only a handful of countries were experiencing double-digit inflation. The role of
central banks was increasingly seen as simply maintaining this benign inflation
environment.
At the same time, there were, however, increasing concerns that the excessive
leverage created by the low interest rate environment could pose financial stability
risks. The prevailing view at the time was that low inflation would be a sufficient
condition for financial stability. It was also generally believed that it was not the duty
of central banks to deal with financial stability risks. This view was epitomised in
Greenspan's address
Alan at the 2003 Jackson Hole Symposium where he argued
that not only were central banks not well equipped to recognise asset price bubbles,
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but that they also did not have the tools to deal with such excesses and that the
best they could therefore hope to do was to clean up once the bubble had popped.
Dissenting voices, notably from Bill White and Claudio Borio2 of the Bank for
International Settlements (BIS), maintained that asset prices were in bubble
territory, driven by excessive bank lending. This view argued that central banks
should not have a narrow focus on inflation and that they should rather lean against
this excessive leverage with higher interest rates and focus on the financial cycle,
which is typically longer than the business cycle. This would have implied
significantly higher interest rates than those prevailing before the global financial
crisis, despite the low inflation environment.
At that stage, when it came to financial stability, the focus of central banks was on
the microprudential regulation and supervision of individual banks and on the
banking system as a whole. Not much attention from a policy perspective was given
towards a
to asset markets. The trend was also increasingly more 'light touch'
regulation of banks, with moves in a number of countries to more self-regulation.
The macroprudential view was not very widespread. At that time, many central
banks had only implicit financial stability mandates or no mandate at all in this
respect. In South Africa, for example, although the SARB had explicit
microprudential responsibilities for regulating and supervising individual banks, we
did not have an explicit mandate to ensure the stability of the broader financial
system.
I should point out that while many central banks were responsible for bank regulation
and supervision, this is not necessarily an exclusive central bank function. In South
Africa, for example, this responsibility was transferred from the then Department of
Finance to the SARB only in 1986. In a number of countries, for example in the
United Kingdom (UK) and Australia, this function was transferred out of the
respective central banks in the 1990s to independent regulators. The UK move was
reversed in the post-crisis period with the establishment of the Prudential Regulation
Authority within the Bank of England.
The global financial crisis brought the need for a broader financial stability focus
starkly to the fore. The dangers that some were warning about were real, and the
2
See, for example, the article titled 'Should monetary policy lean or clean: a reassessment' by W White,
published in Central Banking 19(4) in 2010.
consequences of ignoring them were disastrous. It also became clear that inflation
targeting on its own was not sufficient to guarantee financial stability. Central banks
then found themselves with an increased number of responsibilities. Not only were
they expected to play a leading role in responding to the global recession; they were
now also given explicit financial stability mandates.
The role that central banks play in combatting inflation is clear-cut, but their role in
financial stability is less so. This is because financial stability is multifaceted, and
because not all aspects of financial stability are within the control of the central bank.
In general, therefore, financial stability is a shared responsibility.
While it has now been generally accepted that financial stability should be an explicit
focus of policy, there is no complete unanimity about where this responsibility should
lie and which instruments should be used. The debate has partly centred around the
relationship between monetary policy and macroprudential policy. If interest rates
are used for macoprudential policy purposes, it could result in potential conflicts
between monetary and financial stability policies.
An example is Sweden, where the Riksbank attempted to deal with a perceived
financial stability risk of sharply rising house prices and burgeoning household debt
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by raising interest rates in 2010 even though inflation was below target and the
unemployment forecast was above the estimated long-run sustainable rate. This led
to inflation falling well below the target and rising unemployment, forcing a reversal
of the monetary policy tightening.
One view, put forward by the BIS and others, has argued in favour of using interest
rates as a financial stability tool, but with policy focusing on the financial cycle. This
would result in tighter monetary conditions in the event of excessive leverage, even
if inflation risks were relatively low. The advantage of using interest rates is that it
affects all parts of the financial sector, although this could be a disadvantage at the
same time, as interest rates are seen to be a 'blunt tool', impacting on the cost of
credit in areas where this is not desired. Using the interest rate tool could also result
in higher inflation variability. Although there is evidence that raising interest rates
can reduce leverage and reliance on short-term funding, some analysts have argued
that the required levels could be prohibitively high and impact negatively on growth.
Others, however, have argued that these two policy objectives should be separated,
with different tools applied to different objectives. Lars Svensson, for example,
argues that monetary policy and financial policy are different and distinct policies
that should be conducted independently and with different instruments, although
each policy should take account of the other.3
The well-known Tinbergen rule suggests that there should be the same number of
instruments as there are targets. If the same instrument is used for multiple
objectives, conflicts could occur and trade-offs could be required. According to this
view, interest rate policy should remain a monetary policy tool and be the main
instrument to control inflation. Other policies, which could be well targeted, would
need to be introduced in order to deal with financial stability risks.
This suggests a need for a different committee, separate from the monetary policy
committee. Although it does not necessarily follow that such a committee should be
located within the central bank, it is generally the model that is followed. Sweden is
a notable exception, where the responsibility for financial stability lies outside the
central bank.
There are strong arguments for locating the financial stability function within the
central bank. Charles Goodhart argues that the essence of central banking lies in
its power to create liquidity by manipulating its own balance sheet, i.e. to lend either
to an individual bank or to the market as a whole. To quote him:
"It would cause massive complications if liquidity management remained the sole province
of the central bank while a separate financial stability authority was to be established without
any command over liquidity management. I infer from that that the financial stability authority
has to be given command over liquidity management; but that also implies that the financial
3
Svensson, L E O. (2014). 'Monetary policy and financial stability are different and normally best conducted
independently'. Paper presented to European Central Bank Forum on Central Banking.
There are practical advantages to allocating monetary, microprudential and
macroprudential policy responsibilities to a single institution. Such an arrangement
makes the coordination of different policies much easier, be it through crisis
prevention or crisis management. This is particularly relevant during times of a
financial crisis when the situation tends to deteriorate very rapidly and quick
responses are required.
In South Africa, we have adopted the latter approach. The responsibility for financial
stability has been given explicitly to the SARB, and is overseen by an internal
Financial Stability Committee (FSC). The FSC monitors the broader financial system
but does not regulate or supervise individual banks. This remains the responsibility
of the Bank Supervision Department at the SARB. This department will be
transformed into a Prudential Authority (PA) in terms of the Financial Sector
Regulation Bill (FSR Bill) that has recently been through the parliamentary process
and currently awaits the signature of the President. Once established, the PA will
regulate individual banks, insurance companies, and financial market
infrastructures, while the Financial Sector Conduct Authority, previously the
Financial Services Board, which oversaw the insurance sector, will take
responsibility for market conduct.
The FSR Bill also provides for the establishment of a Financial Stability Oversight
Committee, chaired by the SARB Governor and including representatives from the
Bank, National Treasury, and other financial regulators. The objective of this
advisory committee is to support the SARB in protecting and enhancing financial
stability and to facilitate cooperation and coordination of action among the financial
sector regulators and the SARB in financial stability matters. Within the SARB, the
formulation of macroprudential policy is the responsibility of the FSC. While
monetary, macroprudential and microprudential policy are all separate functions
within the SARB, their coordination is facilitated by being within the same institution
and through some degree of overlapping membership of committee structures.
4
Goodhart, C. (2010). 'The changing role of central banks'. Bank for International Settlements Working Papers
No. 326.
This raises the question as to the nature of macroprudential tools. Many countries
are still grappling with this concept. Part of the challenge is that financial instability
could emanate from multiple and sometimes unexpected sources. A number of
different tools are required to deal with different eventualities. We are also unsure
as to how effective such tools would be and because institutional structures and
banking systems vary widely, we cannot assume that policies which work in one
country would necessarily work in others.
approach is
The SARB's set out in a paper5 released for comment in
November 2016. The macroprudential instruments that are being considered are
classified into three categories, namely capital-based instruments (including
countercyclical capital buffers, sectoral capital requirements, and dynamic
provisions), asset-side instruments (including loan-to-value and debt-to-income
ratio caps), and liquidity-based instruments (including countercyclical liquidity
requirements). These tools are intended to target the sources of systemic risk, such
as liquidity and maturity mismatches, leverage, and interconnectedness. The
advantage of using a more targeted, or function, approach is that it can cover the
shadow-banking sector, asset markets, and the non-financial sector as well.
Financial vulnerabilities do not only emerge from the banking sector.
At this stage, the main policy decision that is made in the FSC relates to the Basel III
countercyclical capital buffer. This is a potential capital add-on to bank capital should
the committee decide to increase the capital requirement of the banking sector as a
whole during an upswing, and should the ratio of credit growth to GDP6 be above its
long-term trend. This would then be reversed during a downswing. Up to now, this
requirement has been set at zero, as the credit gaps are very low.
At present, the focus of the FSC is on identifying any vulnerabilities that could cause
systemic risk. This is done by monitoring potential risks to the system through
assessing various macroprudential systemic risk indicators. These indicators
include macroeconomic, financial sector, market-based as well as other qualitative
indicators. Should any mitigating actions be required, the FSR Bill provides the
5
South African Reserve Bank. (2016). 'A new macroprudential policy framework for South Africa'.
6
gross domestic product
SARB with the powers to advise and/or direct financial regulators to take certain
actions; this is done through the FSC.
Having these additional responsibilities comes with its own set of challenges. The
expanded mandate of financial stability in itself may have implications for central
bank independence. Compared to financial stability, monetary policy decisions,
while not easy, are nevertheless more straightforward and better understood by the
public. These decisions generally involve the use of one tool (the interest rate), and
there is a clear objective.
It is important to appreciate that financial stability is not an end in itself but rather a
means to an end, generally regarded as an important precondition for sustainable
economic growth, serving the constitutional mandate of the SARB. A financial
stability mandate is however more complicated, as it is a shared responsibility. The
political economy aspect of this comes out strongly when we distinguish between
crisis prevention and crisis management or resolution. The policy tools are more
directed at particular sectors, and may therefore be more politically sensitive as the
distributional impacts are more apparent than in the case of monetary policy. There
could be perceptions of particular institutions or sectors being favoured over others.
In particular, crisis management generally involves lender-of-last-resort facilities
and/or providing some sort of assistance to banks that need it. These are inevitably
quasi-fiscal decisions or actions, as they either directly involve government money
or could lead to losses on the central bank balance sheet, which are potentially
losses for government. As we saw during the global financial crisis, there were often
political tensions between the need to save individual institutions in order to prevent
the whole system from collapsing and the moral hazard concerns of bailing out large
institutions. However, even crisis-prevention tools may be politically unpopular,
especially in good times.
Furthermore, as has been argued in an International Monetary Fund staff discussion
note7, financial stability is difficult to measure but crises are evident, so policy
7
Bayoumi, T et al. (2014). 'Monetary policy in the new normal'. International Monetary Fund staff discussion
note.
failures are observable, unlike successes. As noted in the paper, 'central banks
would find it difficult (even ex post) to defend potentially unpopular measures,
precisely because they succeeded in maintaining financial stability'. Any perceived
failures on the financial stability front have the potential to undermine monetary
policy independence through a general loss of credibility of the central bank.
In conclusion, the role of central banks has changed since the global financial crisis.
There is a sharper focus on financial stability issues, and there is also a different
way of looking at these issues. This, however, does not mean that other areas of
policy have been downplayed. In the wake of the crisis, central banks were relied
upon, possibly excessively so, to help the recovery from the global recession and to
avoid deflation. The recovery has taken some time. Fortunately, there appears to
be a sustained recovery in the global economy, and there are now tentative moves
by central banks in the advanced economies to normalise monetary policy settings.
It would also appear that the concerns that extraordinary monetary accommodation
would generate widespread inflation have not transpired. Although central banks
have been given expanded mandates, the role of ensuring price stability has not
been undermined or minimised. It is as important and as relevant as ever, and
remains a crucial pillar of central banking.
Thank you again, Bank of Ghana, for the honour of addressing you at this
celebration of 60 years of central banking in your country.