Seigniorage income has long been a central bank source of finance which, if allowed to be retained, means central banks do not require direct funding from the government of the day in their country. Over the last 40 years central banks have been given increasing independence to manage monetary policy to achieve agreed objectives, particularly financial stability. A recent paper explains why and how this has happened, highlighting some new risks and changes to today’s status quo.
Davide Romelli, an academic at Dublin University, has created and used a database of 2,490 pieces of legislation applicable to central banks in 155 countries between 1972 and 2017. With standardised categorisation he identified laws that changed the independence of central banks from their governments. Using this he has written a paper that considers why and how these reforms took place 1.
Between 1972 and 2008 there were significant changes in the institutional design of central banks, mostly leading to increased independence. Although the rate and timing of the changes varied significantly around the world, even within regions, there is evidence that these changes were important in stabilising inflation.
The categories of reform identified that increased central bank independence, along with the number of acts passed, were:
Board – 201
Policy – 126
Objectives – 108
Lending – 139
Finances – 146
Reporting – 72.
From 2008, and the financial crisis, changes have continued with central banks the emphasis, increasingly only central banks becoming responsible for financial supervision 2. There is also evidence of increasing pressure on their autonomy.
The author created a political economy framework to understand what has been driving the reforms.
1. Status quo bias
2. External inducements, for example reform linked to IMF loans or joining currency unions
3. Crisis and shocks, for example high inflation, but not crisis such as banking, currency or sovereign debt crisis
4. Ideology and political factors, for example government fractionalisation and cabinet changes
5. Economic conditions, such as economic growth.
Factors 2 and 3 applied significantly more to developing countries than others and factors 4 and 5 to advanced economies.
The paper identified three levers for change currently gaining traction.
First is an increase in nationalism and populist governments that tend to reduce independence.
Second, the extensive asset purchase schemes run by central banks since 2008, and particularly to fund the response to the pandemic, has led central banks to hold significant levels of government debt. This increases the risk of fiscal dominance, ie. the risk of monetary policy being undermined and interest rates being pegged at low levels to reduce the cost of servicing sovereign debt.
Finally, although no central bank has formally changed statute to include environmental and climate goals in their mandate, there is clear political pressure to do so.
The UK’s Chancellor of the Exchequer, Rishi Sunak, said in a speech in March 2021 that monetary policy should now ‘also reflect the importance of environmental sustainability and the transition to net zero’.
Christine Lagarde, President of the European Central Bank, said in 2021, ‘climate change [has] macroeconomic and financial implications and [have] consequences for [the European Central Bank’s] primary objective of price stability, other areas of competence including financial stability and banking supervision, as well as for the Eurosystem’s own balance sheet.’
1 - The Political Economy of Reforms in Central Bank Design: Evidence from a New Dataset Davide Romelli (Trinity College Dublin): 74th Economic Policy Panel Meeting.
2 - Examples of this are the Dodd-Franks Act 2010 in the US and similar legislation in New Zealand (2010), the UK (2012), Russia (2013) and the Euro zone (2014).
