Autonomy of Central Banks

nomy of central bank MACROECONOMICS
1.Central banking:
Functions:
-management of public debt of government (agent of government & no autonomy)
-Regulation & supervision of banking entities(Here the role is of lender)
-financing of development activities and other associated functions(in this close coordination with government)
2.central bank independence:
-Personal matters
In this case gov. Distances itself from appointment,dismissal procedures of top central bank officials and governing board
Extent and nature of representation of government in governing body of central bank
-Financial independence:
This indicates freedom of central bank to decide gov expenditure is either directly or indirectly financed via central bank credit
Direct access to central bank implies that monetary policy is subordinated by fiscal policy
-Conduct of policy
This indicates flexibility given to central bank in formulation and execution of monetary policy
Goal Inependence:
Central bank chooses policy priorities of stabilising output or prices at given point of time,hense setting goal of monetory policy.
Instrument Independence:
Central bank is only free to choose the means to achieve objective set by government
Theory:
1.Dynamic or Time inconsistency theory:
-This arises when best plan made for a future period is no longer optimal when the period actually starts
In case of monetory policy this problem arises because there are incentives for a politically motivated policymaker to try to exploit short run trade off between employment and inflation
Expansionary monetary policy-produce high growth and employment in short run,hense policy makers looking for this policy.In long run it leads to high inflation with dangerous consequences.
Remedies/solution for time inconsistency:
-conservative central bank approach
-optimal contract approach
2.Political business cycle theory:
This indicates interaction between economic policy decision and political considerations
Theory highlights tendencies of incumbent gov to generate pre-election booms through expansionary fiscal policy
3.Theory of public choice:
This theory is fusion of politics and economics over last 30 years
To reduce budget deficit,primary solution offered in this theory is constitutional amendment for pre-specified stipulation of central bank credit to government
Secondary solution is-Unless there are constitutional or institutional constraints to contrary,a democracy contains a bias towards deficit finance
Disadvantage of Independence:
Mentioned in ppt slides

Relationship between gov. And RBI:
1.Infancy and uncertainty phase:
Legislation to set up RBI was introduce in jan 1927
RBI is set up as privately owned and managed entity
During this phase,RBI was virtually subservient to the dictates of the gov.and measures were taken to curb its capacity for independent action
2.Maturity phase:
This is phase from nationalisation of RBI in 1948 to nationalisation of major commercial banks in 1969.
After few years of 1948 there was good degree of fiscal rectitude and harmony in monetory and fiscal policy ,hense potential conflicts reduced.
During this phase rate of inflation was modest compared to other developed countries hense success in macro policy management.
In 1960,during this phase,4 areas of conflicts between bank and central gov was proposed those are:
-Interest rate policy
-deficit financing
-corporate credit policy
-management of sub standard banker
-In this phase RBI involved in promoting instutionalisation of credit to gov
-Main objective in this phase was promotion and mobilisation of saving by reinforcing foundation of banking system
3.After 1969:
-Government became owner of no of banks but supervision of these banks was conducted by RBI which was also owned by gov.
-factor affecting relationship was combined effect of gov ownership of comm. Banks and high fiscal deficit.
-RBI credit increases,level of monetisation increases because of transfer of ownership to gov,hense to neutralise the effect of high monetisation of price level RBI increased CRR
-Thus in this phase there was influence or dominance of gov. Over RBI
4.Reforming phase:
-starts from 1990-1991
-changes in monetary policy framework took place in many countries in this period.
-concepts called market determined system and centrally planned economy evolved.
-In India,duringthis period there was a severe balance of payment crises.
-tHere was supplemental agreement between gov and RBI in 1994 in this phase on abolition of ad hoc treasury bills for 1997,this eliminated automatic monetisation of gov deficit and resulted in considerable moderation of monetised deficit.
-Framework of RBI changed with clear articulation of policy goals
-Due to this inflation came to moderate level in India compared to other countries.

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