emmanuel tumusiime - mutebile : the role of the central bank in the post 2015 era to promote local ownership of monetary and fiscal policies and processes special address by mr emmanuel tumusiime - mutebile, governor of the bank of uganda, to the tenth annual meeting of the african science academies, kampala, 11 november 2014. * * * introduction the theme of my address this afternoon is the role, responsibilities and governance of the central bank in a modern market oriented economy, such as that of uganda. if uganda is to create and implement a successful development agenda in 2015 and beyond, it must build strong institutions of economic governance. academics and economic policy makers have learned many lessons about macroeconomic policy and central banking over the last fifty years, and these lessons have influenced radical changes in the practise of monetary policy and the governance of central banks around the world, including in uganda. in some important respects, including the operational independence of the central bank, the adoption of an inflation targeting monetary policy framework and risk based bank supervision, uganda has been among the pioneers of radical reform in africa. in this address i will argue, first, that central banks must have very clear and transparent policy mandates, which are consistent with the policy tools that they have at their disposal. without such mandates, which must command political consensus, central banks cannot be held to account for their performance. this requires that central banks must focus exclusively on monetary policy and bank regulation, and not undertake other roles which might create policy conflicts. secondly, i will argue that central banks need operational independence to pursue their politically determined policy goals. i will explain why this is so important and what it means in practise. thirdly, i will argue that policies which have distributional implications are inherently political and, therefore, should not be the responsibility of a central bank ; instead they should be the responsibility of the relevant government ministry. this principle requires a clear separation of monetary and fiscal policies. what is the proper role of a central bank? central banks are institutions which have a monopoly on the issuance of fiat money ; notes and coins which are legal tender within a given jurisdiction or set of jurisdictions. from this monopoly of the central bank is derived its two critical functions. first, the central bank can determine the quantity of money in circulation in the economy or, alternatively, set the price of this money, which is the interest rate. determining the quantity or the price of money is the essence of monetary policy. no

losses. policymakers with short term horizons include politicians seeking election. a central bank which is not independent of political interference would face pressure to pursue expansionary monetary policies which generate short term gains in output at the expense of higher inflation in the future. granting operational independence to the central bank is, therefore, an institutional mechanism to insulate the central bank from pressures to undertake actions which would have damaging long term consequences, and thus can deliver better monetary policy over the long term. moreover, monetary policy is likely to have more credibility with the private sector if the central bank is insulated from political pressures. in turn, the greater credibility of monetary policy means that the private sector is likely to take a more optimistic view of inflation prospects and, as expectations about inflation are to some degree self - fulfilling, this will help to bring about lower inflation. 4. the separation of fiscal and monetary policy the implementation of monetary policy and bank regulation does not, in general, have significant distributional consequences. for example, an increase in the policy interest rate has macroeconomic affects but it does not usually favour one section of the population at the expense of another. if the implementation of monetary policy and bank regulation had significant distributional consequences, the operational independence of the central bank would be much more problematic, because distributional issues should be determined in the domain of politics, not by technocrats alone. in contrast, fiscal policy is intrinsically distributional in its consequences. how taxes are raised and where government spends public resources does not have an equal impact on all bis central bankers ’ speeches citizens. consequently it is imperative, in a democracy, that elected politicians are closely involved in determining the details of fiscal policy. for example, in uganda all government expenditures must be approved by parliament, as must all public borrowing and all changes to tax policy. this principle is enunciated in the ugandan constitution. given that fiscal policy has distributional consequences and requires parliamentary approval if it is to command political legitimacy, it is imperative that the central bank is not expected to undertake policies which are quasi fiscal in nature, such as providing subsidised credit from its own resources to industries or firms which are regarded as priorities for development. if government desires to pursue such policies, they should be implemented through the government budget, after the necessary parliamentary approval has been obtained. it is essential to maintain a strict separation between monetary and fiscal policies. sound macroeconomic policy also requires the avoidance of “ fiscal dominance ”, which refers to government persistently borrowing