The Necessity of CBI Independence
By Mahdi Goodarzi & Mojde Rezaee
Statistics demonstrates that the inflation rate hovers around 1-3% in advanced economies while it ranges between 3-5% in developing countries, having gone through the following steps to achieve it:
- Tackling the inflation rate problem;
- Deepening their debt market;
- Reforming their banking system; and
- Revisiting their Central Bank (CB) law supporting for its independence.
The current paper reviews the necessity of Central Bank of Iran (CBI) independence, as one of the requisites to maintain the current 1-digit inflation rate.
Economic practitioners unanimously agree and stress on the importance of the CBI independence as a major principle, originating from the fact that such independence will guarantee the integrity and effectiveness of decisions made by this supervisory body.
In all developed economies, CBs have detached their policies from budgetary ones; with the highest level of independence in their CBs, Switzerland and Germany have faced the lowest level of inflation rate. On a flip side, the CBI firstly started its activity as a subsidiary to the government covering its expenses and the government has been able to influence or even veto decisions made by the CBI ever since. In fact, there is sound economic evidence that a significant correlation exists between the CB’s independence level on one hand and the GDP figures as well as stability in prices and foreign exchange rates on the other. This is one reason why unlike more than 100 countries which have less than 5% inflation rate, dragging this rate to below 10% in Iran is interpreted as a huge success.
What Does Central Bank Independence Mean?
The CB independence refers to the separation of monetary and fiscal policies in a country’s economic system, whose greatest result will be the freedom of the CB from the government’s absolute domination; it, therefore, will limit the government’s interference with and influence over monetary policies so it will not be able to borrow from the CB or issue money or bonds to compensate for its budget deficits to whatever degree it desires. The CB independence has 2 features, political and economic; political independence means that decisions will be made by the CB free from government’s pressure while its economic feature translates into the bank’s budgetary autonomy putting an end to the CB giving into the government’s demands for accessing its resources.
Why CB Independence?
Having an independent CB, the government will be relieved to focus on the real part of the economy, including factors like unemployment rate and production volume while the CB will target the volume of liquidity; this way, the economy will benefit from the following:
Correct Economic Objectives
The CB will enjoy autonomy both in setting its objectives and selecting its instruments. While the former means that the CB must act independently from the government in setting its goals, for example, setting a certain inflation rate, the latter stresses that the CB will have the discretion to use measures and instruments it sees fit to hit such targets free from any external pressure. As the result, the monetary tools will not be used to improve the real sector of the economy and an independent body, and not the government, will be in charge of controlling the liquidity volume and inflation rate.
Rise in Transparency in Economy
The inflation rate is one of the major indices showing the government performance in countries grappling with 2-digit inflation rates; this will trigger demands among policy makers to change rates as well as methods to quantify the permissible inflation rates. But, with an independent CB in charge of controlling the inflation rate, more transparency in accountability will also be achieved.
Ability to Prepare Long-Term Economic Plans
In many developed countries, the CB governor tenure is at least 10 years to provide them with a longer term perspective than that of their president whose terms of office is 4 years; this way, the CB governor will be able to consider more precisely the ups and downs of implementing defined policies in the country.
It is largely undisputed that the CB independence will positively affect other markets, including the capital market and sail the economy towards the shore of more stability, although Iran has a difficult path to reach such independence owing to its economy’s dependence on the government and oil revenues.
Dr. Masoud Nili, the economic advisor to President Rouhani, believes that the first challenge ahead of moving towards an independent Central Bank will be the fact that the government in Iran is generally expected to provide the required goods and services in an unlimited volume for citizens. In Iran, people refuse to vote for a government which attempts to offer goods and services at their real prices; rather, they are supportive of the government which not only has access to a money-pot containing all the liquidity available in the country, but also is not afraid of creating new money. Consequently, the definition of the government here involves the hidden budget deficit at its very bottom. The historical imbalance in the country’s annual budgets is in fact an undesired political imbalance stressing on the provision of people’s welfare all by the government.
The second challenge comes from the government’s access to oil revenues; although borrowing from the CBI has been prohibited since the 3rd Development Plan, the purchase of foreign currency from oil export by decree by the CBI, to the extent the government deems necessary, has turned the CBI’s net foreign assets to the major factor of liquidity growth in the country. According to economic facts and justifications, a major part of the current economic conditions is the result of selling foreign currency made from oil export to the CBI and its quick consumption in different fields by the government; consequently, any discussion around the CBI independence without taking into consideration the mechanism to define the relation between foreign currency revenue of the government and the CBI will get nowhere.
The third challenge is related to the government managing a major part of Iran’s commercial banking sector; being owned by the government along with the usury-free banking operation law have made possible the government dominance over commercial banks. Forcing banks to offer facilities in different fields mandated in budgetary clauses is only one sample of the government pressure.
The fourth challenge addresses the general knowledge on the major factors which cause inflation in the country. During the past 5 decades, when inflation rates gradually boomed largely because of the hike in oil prices, budget and consequently, the liquidity volume, acting governments have always tried to blame inflation as the number one reason for the sky high costs, attributing it mainly to speculation. In fact, not only in public but also in many educated citizens’ eyes, there is no significant correlation between the CBI performance, budgetary figures and inflation rate. However, as long as there is enough political power and influence among those who suffer from the CBI independence and there is not sufficient knowledge about it among those who benefit from it, limiting the government’s authority over the CBI will lack the required political capital.
All being said, economic growth and inflation curbing are among targets set out in Iran’s 20 year Vision Plan; targets which are in desperate need of real independence of the CBI and its performance free from political considerations. In this regard, ratifying new regulations to reduce the government interference with the CBI affairs and decisions plus applying necessary oversight measures appear vital; in other words, the manner to appoint the CBI governor as well as the members of the Money and Credit Council must be free of political pressures and changing the CBI governor and its political policies merely due to changes in the government must end as well. However, it is worth mentioning that the CBI independence alone does not solve the current problems in the country and sufficient attention must be paid to improving infrastructures and reforming fiscal and monetary structures to start seeing actual results.
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