Attacks on central bank independence across the globe define macroeconomic outcomes

Central Bank Independence (CBI) which emerged in the late 20th century refers to the degree of autonomy and the unfettered ability of a central bank to conduct its monetary and financial policies. It is a prerequisite for a monetary authority to manage inflation and also restore public confidence in the local currency. It has become the accepted norm of modern central banking until most recently when politicians adopted tendencies of wanting to run the central bank from outside the central bank.

Last week, the Nigerian President Bola Tinubu made a politically motivated decision to sack the Nigerian central bank’s governor and his four deputies. This violated the principle of the CBI that guarantees central bankers a security of tenure irrespective of who has come in as a president. I have been following the relationship between central bankers and their governments, but have rarely seen such a gruesome act on CBI anywhere. The last time I saw such an unprecedented slap in the face of CBI was in 2017 when President Salva Kiir fired his central bank chief, Kornelio Koryom, and deputy governor, John Dor, and gave no reasons for such a wholesale change.

Certainly, this was not the first time a Nigerian president has interfered with the operation of the central bank. In 2014, the then-president of Nigeria, Goodluck Jonathan, dismissed his central bank’s chief and gave no satisfactory reasons for his removal. However, analysts quickly confirmed that ex-central bank chief, Mr. Sanusi Lamido, was a victim of his independent voice against politicians’ interference in the work of the monetary authority.

In 2018, former U.S. president Donald Trump constantly complained about the U.S. Federal Reserve’s chairman, Jerome Powel’s hawkish monetary policy stance. Mr. Trump’s criticism of the Fed’s policies amounted to an interference in the mandate of the central bank.

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In 2016, the Indian government refused to renew the term of the then Reserve Bank of India’s (RBI) governor, Dr. Rughuram Rejan as required by law. This was after Rejan opposed the government’s attempt to demonetise the 1,000 Rupee banknote series, citing some economic consequences.  The post-demonetization consequences were borne out in 2018, two years after Dr.Rajan parted ways with the RBI.

By and large, Dr. Rejan was replaced by Dr. Urjit Patel who later resigned prematurely from the central bank in 2018 after he had had serious differences with Prime Minister Narendra Modi’s government over some economic matters. Mr. Modi lost his cool on Dr. Patel and likened him to “a snake who sits over a hoard of money.” This was after Patel refused to finance the budget deficit by borrowing from the central bank.

Nonetheless, disagreement between central bankers and politicians is not a recent phenomenon and all I have given are just a few examples of the soaring relationship between central bankers and their governments. In 1970, former U.S. president Richard Nixon put undue influence on his central bank’s governor, Arthur Burns, to convince the rest of the Federal Reserve board members to cut the federal fund rate to stimulate the economy so that Mr. Nixon could secure a re-election. Indeed, Mr. Burns gave in to pressure and cut policy rates that boosted employment and Nixon won that year’s election. Since the policy rate cut was to satisfy political expediency, rather than economic one; it did not come at zero cost. It led to double-digit inflation that persisted until the 1980s when the conservative central banker in the name of Paul Volcker was appointed to deal with it decisively and without interference from political leaders.

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After the high and volatile inflationary environment between the 1960s and 1980s, rigorous academic studies have been concentrated in the area of central banking, especially CBI. Inflation was associated with high costs, and the view emerged that CBI could help achieve a better trade-off between output stabilisation and inflation. As a result, the conduct of monetary policy changed dramatically, with almost all advanced economies and many emerging market economies adopting monetary policy frameworks with price stability as their primary objective. To achieve it, central banks were given instrument independence, coupled with policy accountability.

In some African countries like Nigeria and South Sudan, politicians have refused to grant both political and instrumental independence to their monetary authorities and expect them to be accountable. In the event of volatility in the foreign exchange market, they often turn to central bankers for quick solutions to the problems they have created with their misguided policies.

Based on my analysis, the feature of CBI that has been affected most, is institutional independence. This happens as the governments mount serious pressure on monetary authorities to finance budget deficit via overdraft.  Most ministries of finance behaved like they owned the apex banks and that is why they often borrowed from the central bank beyond what has been recommended by the law. For example, the auditor general noted some instances of non-compliance with the requirements of the Bank of South Sudan Act, 2011:Non-compliance with section 65(2) (a) of the act which requires credit accommodations not to be more than 5 per cent of the gross recurrent revenue of the government and related entities, but as of December 31, 2020, the credit accommodation amounting to SSP129, 505 million to the government and related entities exceeded five percent of the extrapolated gross recurrent revenue of SSP 186,400 million from the fiscal report of the central government.

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The deterioration in the central banks’ de facto independence is an issue of concern. Therefore, a consensus has emerged amongst economists that CBI could help to achieve price stability. That said, politicians should give instrument independence to their monetary authorities, while holding them accountable to a well-defined mandate. This will improve monetary policy efficacy by insulating them from political pressures looking to exploit short-term trade-offs between inflation and employment.

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