T T Mboweni: Central bank independence
Speech by Mr T T Mboweni, Governor of the South African Reserve Bank, at the Reuters Forum
Lecture, held in Johannesburg, on 11 October 2000.
* * *
"Independence signifies ignoring pressures, whatever its source. The independence of central banks
goes, ... beyond independence from political, executive and legislative power. For me it also equates
with independence from private or collective economic interests, autonomy versus the short term,
frequently imposed by capital markets and, finally, freedom of action vis-à-vis the monetary policy of
other central banks."
Prime Minister Lionel Jospin. Paris, May 2000.
1. Introduction
I am extremely pleased at this invitation to present this inaugural address in the Reuters Forum Lecture
series. This is an important initiative and I wish you well for the sustained success of this lecture
series.
We have chosen to discuss the issue of central bank independence since the topic is both current and
highly significant. Incidentally when the Banque de France organised their bicentennial celebrations in
May this year, they chose the topic of central bank independence as the theme for the colloquium.
At the said Banque de France colloquium, the Prime Minister of the French Republic, Monsieur
Lionel Jospin remarked that: "the increased power and influence of central banks, the greater visibility
of their role and their leaders, have inevitably focused attention on their role, their efficiency, the
principles underlying their actions and, in some cases, their place in the democratic way of life."
Central banking is of cardinal importance in any country because of the legal right normally granted to
central banks to create money. This money can serve as a means of payment, a unit of account and a
store of value. One of the important issues immediately arising after granting this right to a central
bank, is whether this function should fall under the ultimate control of the executive branch of
government - the cabinet and its administrative departments - or whether parliament should leave this
responsibility to be freely executed by an independent, autonomous powerful institution run by
unelected people.
2. Advantages of an independent central bank
The traditional argument in favour of a strong, independent central bank is that the power to spend
money should in some way be separated from the power to create money. Numerous episodes in the
world's economic history testify to a government's potential abuse of its power to create money.
Around the third century AD in the Roman Empire, for instance, the silver coins collected by the tax
authorities were melted and combined with inferior metals, yielding many more coins to spend on the
Caesar's priorities than the initial tax take. With too much money chasing too few goods, the end
result was high inflation.
Much the same has happened all too frequently with paper money systems. Many governments have
given way to the temptation to reduce interest rates ahead of elections. This may boost spending and
employment in the short term, but ultimately it usually also causes higher inflation over the long term,
unless the capacity of the economy can meet this higher level of demand. This higher inflation,
however, only becomes apparent a couple of years later. An elected government concerned about its
immediate popularity might be tempted to go for the short-term gains from lower interest rates, even at
the risk of promoting somewhat higher inflation further down the road, because some other political
party may then have to pick up the pieces.
Central bankers normally operate on a longer-term time scale than politicians and therefore do not face
the same temptation to relax policy to achieve short-term objectives. By delegating decisions about
interest rates and other monetary matters to such an independent institution, with a clearly defined
mandate, society can hope to achieve a better inflation outcome over the longer term.
A number of studies have been undertaken to determine whether this argument is valid. These studies
all seem to come to the following three conclusions. Firstly, they provided evidence of a negative
correlation between central bank independence and long-term inflation. A low inflation rate is
therefore more likely to be found in countries with independent central banks than in countries where
the central bank is subject to government control. Secondly, they showed that there is a negative
correlation between central bank independence and the long-term budget deficit expressed as a
percentage of a country's gross national product. Countries with independent central banks tend to
have smaller budget deficits than those with government-controlled central banks. Thirdly, the studies
in general did not find any evidence of a correlation between the independent status of a central bank
and production growth. It therefore does not follow that production or employment will suffer as a
result of the independent status of the central banks over the medium to long term.
3. Risks of central bank independence
Some critics of an independent central bank argue that although the average inflation rate and the
degree of central bank independence are negatively correlated, this relationship does not reflect any
causal link running from central bank independence to low inflation. They argue that countries where
the electorate is particularly averse to inflation, are more willing to keep inflation down. These
countries are also more likely to have made their monetary authorities functionally independent so as
to help preserve low inflation. Germany, affected severely by the hyperinflation of the Weimar
Republic, is an obvious case in point.
Conversely, countries where the electorate are more tolerant of inflation, are also less inclined to see
monetary policy turned over to an autonomous central bank. These critics claim that average inflation
is determined by history and the preferences of a country's inhabitants with causality running from
inflation to the institutional structure. According to this view, attempts to impose an independent
central bank and with it a more purposeful anti-inflationary stance in a country tolerant of inflation, are
doomed to failure. The outcry against restrictive policies would simply be too great for the central
bank to withstand.
This argument is not very convincing and does not seem to fit, for instance, the recent experience of
New Zealand. For most of the postwar period the Reserve Bank of New Zealand was one of the least
independent central banks in the OECD. However, in 1988 it was transformed into one of the most
autonomous, with a very clear mandate to fight inflation. This helped the inflation rate to plummet
from double-digit levels to under 2%, which strongly suggests that the structure of monetary
institutions together with the determination to combat inflation, can be highly successful.
Another argument against the autonomy of central banks is that they form part of overall economic
policy and that there can be no meaningful separation between fiscal policy, monetary policy, labour
policy, trade policy or for that matter any other policy measures. If such a separation is attempted and
if policies run at cross-purposes, then conflicting objectives will have to be solved one way or another.
In the process, a conflict between the policies may inflict considerable damage on the economy. There
is clearly substance in the argument that a tightly coordinated package of policies has a better chance
of success than a set of conflicting ones. It can nevertheless be argued that such conflicts may be
inevitable over the short term, as long as central banks have the primary responsibility for controlling
inflation. However, over the long term, stable financial conditions promote sustainably higher
economic growth rates, increased welfare and more employment opportunities.
The main criticism against making central banks autonomous entities is based not so much on
economic as on political arguments. The political argument is that turning over decisions about
interest rates, exchange rates, the efficiency of the financial system and other monetary matters to a
body of unelected officials, is simply "undemocratic". In a democratic society, it is argued, all
decisions should be subject to scrutiny by the elected members of the legislature and the concept of an
autonomous central bank is therefore not acceptable. Although there are plenty of other areas of
national life where decision making is delegated to independent unelected officials - the judiciary is a
prime example - there is a fundamental confusion here between being independent and lacking
accountability. No central bank can be totally independent, in the sense that it is not answerable to
anyone. Even the most autonomous central bank has to report in some form or another to the
legislature, which in any case also has the ultimate power to change the laws governing the central
bank. All the same, there is a difference between a situation where policy decisions are under
continuous scrutiny, and an arrangement where the central bank reports to the legislature periodically.
The issue of independence and accountability also turns on the nature of the relationship between the
government and the legislature as the political authorities on the one hand and the central bank on the
other. At the same colloquium mentioned above, Monsieur Jean-Claude Trichet, Governor of the
Banque de France, observed that: "respecting independence does not mean a lack of dialogue, on the
contrary. However, it is true that an independent central bank is neither accountable to the executive
power, nor to parliament, nor any other political institution. In France this was decided by the law
makers, and in Europe by the will of the people and the European Parliaments, which ratified the
Maastricht Treaty."
In the case of the European Central Bank (ECB), the independence of the Bank is explained under
Article 7 of the Statute which says that: "When exercising the powers and carrying out the tasks and
duties conferred on them by this Treaty and this Statute, neither the ECB, nor a national bank, nor any
member of their decision-making bodies shall seek or take instructions from community institutions or
bodies, from any government of a member state or from any other body."
The key issues here quite clearly are independence, accountability and dialogue with the political
authorities.
In South Africa the Governor of the Reserve Bank must submit a report annually to the Minister of
Finance relating to the implementation of monetary policy. In terms of Section 32 of the Reserve Bank
Act, the Bank must also on a monthly basis submit a statement of assets and liabilities and annually its
financial statements to the Department of Finance. These reports are then tabled in Parliament by the
Minister of Finance.
Moreover, Section 37 of the Act provides further that if at any time the Minister of Finance is of the
opinion that the Bank has failed to comply with any provision of the act or of a regulation made
thereunder, he may by notice in writing require the Board of the Bank to make good or remedy the
default within a specified time. If the Board fails to comply with such a notice, the Minister may apply
to the Supreme Court for an order compelling the Board to make good or remedy the default, and the
Court may make such order thereon as it deems fit.
4. Conditions for independence
In view of these risks involved in central bank independence, there are usually three preconditions for
central bank autonomy. Firstly, there should be a clearly spelled out legal and operational framework
in which monetary policy is conducted. In the legal framework, the central bank's independence
should be defined to avoid any misconceptions of what the central bank is supposed to achieve. In the
monetary policy framework, the central bank must indicate what it is attempting to achieve, what
operational variables it will apply and what monetary instruments it will use to achieve its objective.
Because credibility is usually not gained overnight, it is important that a longer-term programme
should be drawn up to show how the central bank will fulfil its mission.
A second condition for greater autonomy is transparency. The government and the public should
continuously be informed of the monetary policy programme followed by the central bank. Regular
discussions between the central bank and the government will be necessary and some form of
accountability to parliament will have to be established. It is also important to explain monetary policy
decisions regularly to the public, together with an assessment of the progress made in achieving stated
objectives. Priorities in the programme as well as operational instruments should be clearly spelled
out, in order to keep the public well informed about developments and changes in monetary policy.
The third condition for central bank autonomy is the creation of an efficient institutional framework
within which decisions on monetary policy and on its implementation can be made, without undue
interference by political functionaries. This involves decisions regarding:
(i) functional independence, which means the right to decide on all matters regarding monetary
policy and price stability;
(ii) personnel independence, which covers the selection and appointment of Board members
with a high professional competence and without an obligation to yield to political and other
pressures;
(iii) instrumental independence, which means control over the instruments that affect the
inflation process, including in particular the prevention of any direct financing of
government deficits; and
(iv) financial independence, which requires the central bank to have access to adequate financial
resources of its own and full control over its own budget.
5. Legal and operational procedures in South Africa
The legal framework may provide an important foundation on which independence can be built, by
giving clearly defined tasks to the central bank and demanding compliance in carrying out those tasks.
By the early 1990s, when South Africa's Constitution was being drafted, central bank independence
had already become a fairly widely accepted element of sound central banking in the international
debate. This acceptance was shaped by the dismal experience of the many countries that had suffered
high inflation in the 1970s and 1980s. Both the interim and the final Constitution of the Republic of
South Africa therefore provide for an independent central bank. Section 224(2) of the Constitution
states very clearly: "The South African Reserve Bank, in pursuit of its primary object must perform its
functions independently and without fear, favour or prejudice, but there must be regular consultation
between the Bank and the Cabinet member responsible for national financial matters."
In operating within this legal framework, the Reserve Bank has indicated that its primary goal in the
South African economic system is the achievement and maintenance of financial stability. The Bank
believes that it is essential that South Africa has a growing economy based on the principles of a
market system, private and social initiative, effective competition and social fairness. It recognises, in
the performance of its duties, the need to pursue balanced economic development and growth.
In the pursuance of its responsibilities, the Reserve Bank assumes responsibility for:
(i) assisting the government, as well as other members of the community of South Africa, in the
formulation and implementation of economic policy;
(ii) formulating and implementing monetary policy in such a way that the primary goal of
monetary policy will be achieved in the interest of the whole community;
(iii) ensuring that the South African money, banking and financial system as a whole is sound,
meets the requirements of the community and keeps abreast of developments in international
finance; and
(iv) informing the South African community and all interested stakeholders abroad about
monetary policy generally, and the South African economic situation in particular.
As is well known, South Africa adopted a formal inflation-targeting framework for monetary policy in
February of this year. Time does not allow a long discussion of this framework. However, it may be
noted that it makes the aim of monetary policy much clearer, ie the achievement of an average annual
increase of 3 to 6% for CPIX inflation in 2002. The government chose to set the 3 to 6% target level.
The setting of monetary policy instrument values (like the level of the "repo rate") is entirely up to the
Reserve Bank. Therefore the inflation-targeting variable chosen provides for the instrument
independence of the Reserve Bank, but not goal independence.
By means of the mission statement and an explanatory memorandum about the adoption of an
inflation-targeting monetary policy framework, the public has been informed about the objectives of
monetary policy. On the basis of this information the public can therefore evaluate the actions of the
Reserve Bank in attaining these objectives.
6. Transparency of monetary policy
The South African Reserve Bank also fulfils the second condition for independence, namely
transparency. Government and the public are provided with a stream of information on the monetary
policy stance. Some of my staff and I regularly appear before the Parliamentary Portfolio Committee
on Finance. We also issue comprehensive statements following each meeting of the Bank's Monetary
Policy Committee. The Reserve Bank's Quarterly Bulletin, Annual Economic Report and Governor's
Address at the annual meeting of shareholders provide comprehensive analyses of macroeconomic
events. A six-monthly Monetary Policy Review will soon be introduced, describing in more detail the
decisions taken by the Reserve Bank. Policy is also explained by the Governors of the Bank and
comments on policy are heard at the Monetary Policy Forum meetings. These meetings are held twice
a year in the main centres - at least one in each province - and involve organised business, labour,
politicians, academics and the media.
7. Institutional independence in South Africa
Finally, the present institutional framework in South Africa in the form of the South African Reserve
Bank Act, Act No 90 of 1989, allows the Reserve Bank a great degree of autonomy in its operations.
The Reserve Bank's functional independence in monetary and related policies is clearly stated in
Sections 10 and 35 of the South African Reserve Bank Act. Section 35 empowers the Board of the
Bank to make rules "for the good government of the Bank and the conduct of its business". In
Section 10 the powers and duties of the central bank are spelled out in great detail. Most of the
functions described in this section are the normal functions that one would expect a central bank to
perform. Section 10(2) also clearly states that "the rates at which the Bank will discount or rediscount
the various classes of bills, promissory notes and other securities, shall be determined and announced
by the Bank from time to time", plainly giving the Bank the right to determine Bank rate, or rather the
repo rate, in an autonomous manner.
As banker to the government, however, the Bank administers exchange control regulations, monitors
the prudential soundness in the banking system and handles the weekly tenders for Treasury bills and
government securities. The Reserve Bank also takes care of various aspects of South Africa's dealings
and relations with institutions such as the International Monetary Fund and the World Bank on behalf
of the government. In performing these activities, the Bank only acts as an agent of government and
the final responsibility and decision-making rest with the Minister of Finance. This kind of activity can
undermine the functional independence of the Reserve Bank.
The personnel independence of the Reserve Bank is determined in Section 4 of the Act, indicating the
conditions of appointment of the Governor, three deputy governors and other Board members of the
Reserve Bank. This section clearly precludes any person actively involved in politics, non-residents or
officials of private banks from becoming a member of the Board of the Bank. Seven of the directors,
including the Governor and three deputy governors, are appointed by the President of the Republic,
and the other seven are elected by the shareholders. By means of these appointments the government,
of course, does, as some would argue, have an effective say in the policies of the Bank. The governors,
however, after their appointment, normally operate independently without fear or favour.
Certain conditions are given in the Regulations under the Reserve Bank Act which will disqualify a
person for remaining a Board member, such as conviction for theft, fraud, forgery or perjury.
However, mechanisms for the dismissal of governors are not entrenched in the Act. Grounds for
dismissal and the actual procedure could perhaps be more explicitly stated in legislation to improve
the functioning of the Reserve Bank. Consideration could also be given to lengthening the tenure of
office of the Governor and deputy governors, say to seven years, to improve the autonomy of the Bank
further by separating the five-yearly political cycle from the appointments of governors.
The instrumental independence of the Reserve Bank is also clearly spelled out in the Act and the
Reserve Bank is precluded in Section 13(f) from making excessive direct purchases of government
stock. This section states that the Bank may not "hold in stocks of the Government of the Republic
which have been acquired directly from the Treasury by subscription to new issues, the conversion of
existing issues or otherwise, a sum exceeding its paid-up capital and reserve fund plus one third of its
liabilities to the public in the Republic". This section therefore restricts the direct financing of
government deficits.
At the same time, the Act also allows the Reserve Bank to provide unsecured loans and advances to
government and companies in which it has acquired shares. Although there are limits on government
borrowing, serious consideration in the revision of the Reserve Bank Act should be given to removing
this potentially dangerous provision.
The South African Reserve Bank is also financially independent from the government because of its
adequate financial resources and full control over its own budget.
8. Conclusion
In pursuing financial stability, the South African Reserve Bank is relatively well aligned with
international best practice. It operates autonomously within a legal framework which affords it a
substantial degree of independence, while remaining accountable to Parliament. But ultimately it is the
appreciation by the public at large of the importance of financial stability, and their understanding of
and support for the role of the Reserve Bank in this regard, that is needed to entrench and develop the
Bank's independence. To this end, ongoing communication between the Reserve Bank and all levels
of society is essential. In this connection, Governor Jean-Claude Trichet asked the question: "So to
whom is the central bank accountable? In the end, I think it is accountable to public opinion itself. It is
our great responsibility to communicate with public opinion as a whole, and not just market operators
and investors. This communication must be as direct and precise as possible, in terms as simple as the
subject matter allows while remaining very professional."
While we are fully aware that we face many daunting challenges, it is gratifying to note the degree of
financial stability that has been attained over the past years. And it is exciting to note that financial
stability provides a sound basis for sustainable strong economic growth and development; more and
more evidence suggests that central bank independence and prudent policies in general are starting to
pay off in South Africa.