A central bank may also have the supervisory powers necessary to ensure that banks and other financial institutions do not behave recklessly or fraudulently. It is usually headed by a governor who is sometimes picked by the current government. In the case of the European Central Bank, a president presides over the bank and in Singapore there is a Chief Managing Director. Jamaica has a board of directors who are in charge of the bank and who are appointed by the Minister of Finance.
The following is an excerpt from the official website of the Bank of Jamaica. The excerpt is an overview of the banks functions and its roles.
“The central bank stands at the centre of the local financial system and is charged with the responsibility to promote and maintain financial system stability. In order to achieve this, the Bank seeks to promote the development of the local financial markets and regulates and supports the major clearing and settlement systems through which financial institutions execute securities transactions and transfer funds. The safety and efficiency of these payment systems are therefore critical objectives of public policy”
The functions of the Central Bank can be summarized as:
- to the government
- to recognized banks
- to overseas central banks
- It manages the government’s borrowing program
- It overseas the activities of banks and other financial institutions
- It provides liquidity to banks
- It operates the government’s:
- monetary policy
- exchange rate policy
In the majority of the world, the central bank is owned by the state. This state ownership gives the central bank very little independence as the government is able to intervene into monetary policy and all other major decisions. Jamaica’s central bank is state owned and answers directly to the Minister of Finance. However, with the general movement in recent years to make central banks independent, Jamaica’s central bank may soon become independent. The independent B.O.J. would operate under rules which would be designed to prevent political interference.
Why Should the Central Bank be Independent?
Since the late 1980’s, more and more countries have freed their central banks from political control. The have made their banks independent because of evidence showing that this independence had a successful record of achieving monetary stability. One can see from the graph below the evidence. The central bank of the countries listed was made independent (on average) in 1986. It is seen that the inflation rates are considerably lower then when the country had a regulated central bank.
Central bank independence is seen as essential by many to counter the natural preference of politicians for expansionary economic policies that promise short term electoral gains at the risk of worsening inflation in the long run. Making central banks independent frees them from political pressure and thus removes the inflationary bias that could otherwise unsettle monetary policy.
Another reason to call for independence is that political interference more often then not makes a bad situation worse. Political pressures not only weaken financial regulation, but also hinder regulators and supervisors who enforce the regulations against banks that run into trouble. In doing so the politicians cripple the financial sector in the run-up to the crisis, delayed recognition of the severity of the crisis, slowed needed intervention, and raised the cost of the crisis to taxpayers. For example, the Venezuelan crisis of 1994 was caused by ineffective regulation, weak supervision, and political interference. These weakened the banks causing the financial sector to be rocked.
Another very important reason for independence is that it prevents politicians from abusing the banking system. A budget deficit will be covered by a loan from the central bank. If the bank is controlled by the government they have to give the government the loan. However, an independent central bank will only have to follow the rules that it was set up under and does not have to give the government the loan unless it feels like the country desperately needs it.
Why Should the Central Bank be Regulated?
The regulation of any institution is done for the main purpose of consumer protection. The regulation of such industries as telecommunications and nuclear production has been done so as to insure the safety of the public. The American government regulated the telecommunication industry in 1970s - 1980s so as to prevent the industry from charging monopoly prices. Nuclear production in a country is regulated by the government of that country, the world over, so as to prevent cataclysmic accidents and to prevent the improper use of nuclear materials. The same is true in the financial sector. It is regulated by the government so as to insure that consumers are not cheated, nor will they have their money stolen. The government will help to prevent the excuses and failures of a market left to itself. It is argued by regulation supporters that someone must be held responsible, that is the Government, for any problems in the monetary policy and the instruments that are used to accomplish this monetary policy (see Section1).
Public protection was advocated by George J. Stigler, Nobel Prize winning economist. He said, “agencies tend to respond to the wishes of the best-organized interest groups. When regulators are free from political control, the risk of ‘regulatory capture’ by other groups - in particular the industry they regulate - grows... and industry capture can undermine the effectiveness of regulation just as political pressure can.”
A second reason for regulation is when it is under the control of the government the two can work effectively together. The monetary policy is dependent on both the Government and the central bank and thus when the central bank is independent the co-ordination of the two can be affected. Often times, one will not agree with the other and this will create time delays when a decision must be made to counter some problem in the economy. Also, many decisions that would be left up to an independent central bank go against democracy. It is not democratically correct to have a board of directors deciding on policy that no other individual has say in.
The main reason for monetary policy is to control inflation which is the general rise in prices. The central bank will use its various means to combat inflation. This is a very important task. Inflation must be controlled so as to reduce the gradual decline of the money of a country. No one wants to be continually paying more for the items they buy everyday. However, deregulation hinders the reduction of inflation because often times the government will not work together with the Central Bank to lower inflation. The government will often times pursue programs that increase aggregate demand which help to fuel inflation.
Therefore, although independent central banks promise lower inflation, this lower inflation may be countered by other government policies.
Conclusion
The benefits and disadvantages to giving the central bank its independence have been discussed, but it is my opinion in the case of Jamaica that the costs outweigh the benefits. It should be the aim to one day free the central bank so that it can be more efficient, lower inflation, and prevent needless borrowing, however with the current situation of the country’s political situation it would be impossible to have a proper independent central bank.
The inflationary policies that this government is currently pursing would counter the deflation that the central bank could gain. Also, the political cowardice of many politicians to take responsibility for their actions would hinder the bank as no one would want to take accountability for its actions. Nor is the government strong enough to prevent the central bank from being influenced by outside forces (private and foreign banks).
It is better for the B.O.J. to stay how it is now. When the government can be restructured and when the government finally realizes that inflation and the uncontrolled debt must be addressed then it should be made independent. If it was to be done now, it would only put a heavier strain on our already burdened economy.
Bibliography
- Economics - Fifth Edition John Sloman
- Principles of Economics - Sixth Edition Lipsey and Chrystal
