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Public and academic debate on monetary policy

Jamaluddin Ahmed | Published: June 18, 2016 18:42:01 | Updated: October 18, 2017 00:51:13


The persistence of currency pegs through much of the 20th century and the tendency to regard as aberrant and exceptional periods when those pegs were in abeyance are one way of understanding why there was not more intense pressure for central banks to reveal more information about their operations. It was easy enough to judge, on the basis of events in foreign exchange markets, whether the central bank was true to its mandate. This perspective suggests it is no coincidence that the tendency in the last ten years for central banks to become more transparent in other aspects of their operations coincided with a shift toward more flexible exchange rates. In a growing number of countries, the single thing that had done the most to lend transparency to monetary policy disappeared. The result was pressure to increase other aspects of transparency, if for no other reason than to enhance society's ability to hold central banks accountable to their ultimate stakeholders.
To be sure, this shift toward greater exchange rate flexibility was not exogenous. It did not occur in isolation from other events in economy and society. As some people argue that, it is best understood in terms of two other late 20th century trends: financial liberalisation and political liberalisation. The deregulation of financial markets and the removal of controls on international financial flows made it impossible for central banks and governments to use one instrument to hit two targets - to peg the exchange rate while at the same time using monetary policy to pursue other goals. Meanwhile, democratisation made it more difficult to privilege the exchange rate - to credibly commit to pegging the exchange rate without regard to the implications for other socially relevant economic variables. When unemployment rose to high levels, for example, political pressure on the central bank to do something about it became irresistible. In an environment of deregulated financial markets and capital flows, the exchange rate peg was increasingly a casualty. This was a first channel through which there was impetus to develop further other aspects of central bank transparency.
DEMOCRATISATION AND FINANCIAL LIBERALISATION: There were also other channels linking democratisation and financial liberalisation to central bank transparency. Democratisation directly increased demands for public accountability. Democratic governments are intrinsically more open about their affairs as a way of achieving accountability to their constituents; in this sense central bank transparency (the central bank being an agency of the government) is only a specific instance of the general point. And transparency is one way in which such public accountability can be brought about. It is surely not coincidental that the rise in central bank transparency in Latin America, in Eastern Europe and in Asian countries from Korea to the Philippines, Bangladesh, India and Sri Lanka coincided with the third wave of democratisation and shifting of paradigm from command to market.
Democratisation also strengthened the argument for central bank independence, a trend that is closely allied to increased transparency. In democratic societies, political pressures are intense (in a sense, this is the very definition of democracy), and there are a variety of arguments for why central banks, when deciding on their tactics, should be sheltered from those pressures via independence. With the grant of independence come demands for adequate accountability; central banks are asked to provide more information about their operations to enable citizens and their representatives to evaluate their actions, appreciate their achievements, and take them to task for their failures. In addition, independence may render a central bank more willing to volunteer information about its operations; when a central bank is dependent on the government, keeping information private is one way that it can advance its own goals relative to those of its political masters.
The financial liberalisation made it important that central bank actions should have a stable and predictable impact on market variables. Deregulation eliminated the authorities' ability to control market outcomes directly. The growth of financial markets and transactions made the market response to policies all the more essential for achieving the central bank's ultimate objectives. Volatility, when it occurred, was even more disruptive than before. This made it more important that the central bank communicates with market participants in a way that inspired confidence and avoided causing excessive volatility. Insofar as communication means the regularised transmission of information, the implication was an increase in the extent of central bank transparency.
Also central bank transparency has become the topic of a lively public and academic debate on monetary policy. The public demands transparency to achieve accountability of central banks that have increasingly become independent. The debate on transparency has been complicated by the fact that it is a qualitative concept for which few measures exist. This article discusses the transparency of monetary policy and other issues that comprise the political, economic, procedural, policy and operational aspects of central banking. Transparency of monetary policy can be defined as the extent to which central banks disclose information that is related to the policymaking process. It is a multifaceted concept that could pertain to any aspect of monetary policymaking. Thus, it seems natural to use a conceptual framework that reflects different stages of the decision-making process. Following Geraats (2002), one can distinguish five aspects of transparency: political, economic, procedural, policy and operational transparency. These aspects of transparency correspond to information disclosure about the stages of monetary policymaking.  Political transparency refers to openness about policy objectives. This comprises a statement of the formal objectives of monetary policy, including an explicit prioritisation in case of potentially conflicting goals, and quantitative targets. Political transparency is enhanced by institutional arrangements, like central bank independence and central bank contracts, because they ensure that there is no undue influence or political pressure to deviate from stated objectives.
Economic transparency focuses on the economic information that is used for monetary policy. This includes the economic data the central bank uses, the policy models it employs to construct economic forecasts or evaluate the impact of its decisions, and the internal forecasts the central bank relies on. The latter are particularly important since monetary policy actions are known to take effect only after substantial lags. So, the central bank's actions are likely to reflect anticipated developments. Procedural transparency is about the way monetary policy decisions are taken. It involves an explicit monetary policy rule or strategy that describes the monetary policy framework, and an account of the actual policy deliberations and how the policy decision was reached, which is achieved by the release of minutes and voting records. Policy transparency means a prompt announcement of policy decisions. In addition, it includes an explanation of the decision and a policy inclination or indication of likely future policy actions. The latter is relevant because monetary policy actions are typically made in discrete steps; a central bank may be inclined to change the policy instrument, but decide to wait until further evidence warrants moving a full step. Operational transparency concerns the implementation of the central bank's policy actions. It involves a discussion of control errors in achieving the operating instrument or target set in the policy decision, and (unanticipated) macroeconomic disturbances that affect the transmission of monetary policy from instrument to outcome.
A central bank is a public institution and as such it must be fully accountable for all its actions and procedures. This broad and uncontroversial principle establishes the basic presumption that all information ought to be released, unless a good case can be made to the contrary. Such a case can be and usually is made regarding proprietary information on financial institutions that central banks routinely collect, or receive in periods of financial instability. More generally, market-sensitive information requires particular care to ensure a level-playing field among competing financial institutions. With these exceptions in mind, we do not see other generic information that central banks ought to conceal from the public domain. How in practice do central banks cope with this principle?
The force of the principle is felt differently from one democratic country to another. In several countries, the culture of government openness is not solidly entrenched. In these countries government and government-related activities have long been, and still are, perceived as deserving some degree of secrecy. This historical heritage is gradually giving way to the trend towards openness. For instance, legislative and legal avenues have been actively pursued in countries such as France and Italy, and will no doubt continue to crack the instinctive tendency of bureaucracies to protect themselves from the full light of public scrutiny. It is interesting to note that the multinational Eurosystem-and the European Commission as well - is struggling to mesh these different cultures into commonly accepted norms. Communication is at the heart of accountability. Whatever the legal process through which they fulfil their obligations, central banks cannot operate successfully unless they enjoy broad support among their various constituencies. They occasionally have to enforce policies which impose hardship on broad segments of the population. Hardships are only tolerated if the central bank has won the trust required to lead. In addition, a central bank will be more efficient the better its motives and procedures are understood. This is why, in good as in bad times, central banks must talk to their various constituencies.
Jamaluddin Ahmed PhD, FCA is General Secretary, Bangladesh Economic Association.
jamal@emergingrating.com
 

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