Central Bank Independence: Why It’s Needed and How to Protect It
IMF News, June 14, 2024
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Bibliographic details
- Published: June 14, 2024
Context and main message
- Speaker and setting: Tobias Adrian, IMF Financial Counsellor and Director of the Monetary and Capital Markets Department; Bank of Thailand Annual Retreat; June 14, 2024.
- Core proposition: “Independence is critical to winning the fights against inflation and achieving stable long-term economic growth.”
- Key observation: Many central banks face heightened pressures—post-pandemic inflation, political scrutiny, expanded mandates (financial integrity, financial inclusion, consumer protection, fintech, climate), larger balance sheets, and increased expectations from parliament and market participants.
Evidence on why independence matters
- Empirical link: Higher central bank independence is associated with lower inflation.
- US example: Expectations of inflation in the US have stayed anchored around 2 percent, attributed predominantly to the independence of the Federal Reserve.
- Political vulnerability: Pressure on independence can intensify around general elections and affects advanced, emerging, and developing economies.
New global index for central bank independence
- Development: New global index developed by Tobias Adrian, Lev Menand, and Ashraf Khan.
- Novelty: First new central bank independence index in 30 years.
- Basis and methodology:
- Built on ten metrics (referenced as Figure 1 in source).
- Includes new variables such as financial and budgetary independence, board composition, and the role of state audit bodies.
- Uses data from critical IMF databases.
- Weighting and application informed by an extensive survey of 87 central banks worldwide.
- Comparative scoring: The index is more conservative than existing indices and scores advanced economies less extremely higher relative to emerging and developing economies.
- Correlation: The index is the first that correlates positively with inflation-targeting central banks.
Common weak points in independence (survey and analysis findings)
- Areas of weakness identified:
- Governor- and Board-level independence.
- Budget and financial independence.
- Monetary policy independence.
- Prohibition of short- and long-term lending to government and prohibition of lending outside the financial system.
- Central banker priorities:
- Financial independence rated as the most critical component.
- Prohibition of short-term lending to government rated as comparatively less important.
IMF tools to strengthen independence and policy credibility
- 1) IMF Central Bank Transparency Code (CBT)
- Publication year: 2020.
- Structure: Five pillars covering governance transparency, policy transparency, operational transparency, outcomes transparency, and official relations with key stakeholders (referenced as Figure 2).
- Design principle: Applicable to any central bank and recognizes legitimate confidentiality needs (e.g., foreign exchange interventions, sensitive or personal data).
- Benefits of a CBT Review (four-fold):
- Improves transparency practices and communication framework, leading to policy credibility.
- Strengthens relations with stakeholders (parliament, market participants, public).
- Facilitates peer-learning among central banks.
- Helps other IMF engagements (e.g., financial sector assessments).
- Recent CBT Reviews: Central banks of Canada, Chile, Oman, and South Africa.
- Notable outcomes from CBT Reviews:
- Bank of Canada published internal deliberations after each policy rate announcement for the first time.
- Bank of Chile published a detailed roadmap for additional transparency measures and presented it to parliament.
- National Bank of North Macedonia presented CBT findings to the Ministry and parliament and highlighted use of independence to conduct effective policies beyond political cycles.
- 2) Central bank balance sheet stress testing
- Purpose: Assess financial independence by modelling balance sheet evolution and capital under extreme but plausible scenarios.
- Relevance:
- Advanced economies: Expanded balance sheets post-pandemic from quantitative easing create interest rate and duration risks not always captured in capital policies.
- Emerging markets: Large foreign exchange portfolios create exposure to exchange rate losses that can affect profit distribution and create fiscal risks, including possible recapitalization needs.
- Output: Granular projections of balance sheet state and capital effects over time to inform board decision-making and government discussions.
- 3) Central bank operational efficiency review
- Finding: Emerging market central banks have significantly higher operational costs and are significantly less efficient than central banks in advanced economies (depicted in Figure 3).
- Scope: Calculates cost efficiency excluding policy-related costs; benchmarks staffing, procurement, cash currency management, subsidiaries, building maintenance and other logistics against international best practices and comparable domestic agencies/central banks.
- Purpose: Help Boards make informed operational cost decisions and explain them to stakeholders, thereby strengthening independence.
Policy implications and recommendations (actionable points)
- Prioritize strengthening financial and budgetary independence—rated most critical by central bankers and offering high leverage (“bang for the buck”) in enhancing independence.
- Use non-legislative pathways where possible:
- Undertake a CBT Review to improve transparency, stakeholder relations, and policy credibility without immediate legislative reform.
- Deploy central bank balance sheet stress testing to quantify fiscal and capital vulnerabilities and inform governance decisions and government dialogue.
- Perform operational efficiency reviews to reduce non-policy costs and improve justification of budgetary needs to stakeholders.
- Communication: Central banks should ensure careful communication while remaining steadfast in monetary policy decisions to maintain credibility amid political scrutiny.
Conclusion
- Summary point: While many central banks are under pressure, independence delivers long-term benefits. There remains room for improvement in many central banks, and the IMF offers tailored tools—CBT Reviews, balance sheet stress testing, and operational efficiency reviews—used worldwide to strengthen independence and policy credibility.
Source: Central Bank Independence: Why It’s Needed and How to Protect It (IMF), speech by Tobias Adrian, June 14, 2024.