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Issues in central bank finance and independence

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  • Peter Stella
  • Åke Lonnberg
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    Abstract

    Conventional economic policy models focus only on selected elements of the central bank balance sheet, in particular monetary liabilities and sometimes foreign reserves. The canonical model of an "independent" central bank assumes that it chooses money (or an interest rate) unconstrained by a need to generate seignorage for itself or the government. Whereas a long line of literature has emphasized the dangers of fiscal dominance influencing the conduct of monetary policy, this paper considers the relatively novel idea that an independent central bank could be constrained in achieving its policy objectives by its own balance sheet situation. If one accepts this potential constraint as a valid concern, the financial strength of the central bank as a stand-alone entity becomes highly relevant for ascertaining monetary policy credibility. We consider several strands of evidence that clearly indicate fiscal backing for central banks cannot be assumed, and hence financial independence is relevant to operational independence. First, we examine 135 central bank laws to illustrate the variety of legal approaches adopted with respect to central bank financial independence. Second, we examine the same data set with regard to central bank recapitalization provisions to show that even in cases where the treasury is nominally responsible for keeping the central bank financially strong, it may do so in purely a cosmetic fashion. Third, we show that, in actual practice, treasuries have frequently not provided central banks with genuine financial support on a timely basis, leaving them excessively reliant on seignorage to finance their operations or forcing them to abandon policy objectives.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2008-13.

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    Date of creation: 2008
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    Handle: RePEc:fip:fedawp:2008-13

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    Keywords: Banks and banking; Central ; Monetary policy;

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    References

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    1. Alfred Broaddus & Marvin Goodfriend, 1996. "Foreign exchange operations and the Federal Reserve," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-20.
    2. G. A. Mackenzie & Peter Stella, 1996. "Quasi-Fiscal Operations of Public Financial Institutions," IMF Occasional Papers 142, International Monetary Fund.
    3. Peter Stella, 1997. "Do Central Banks Need Capital?," IMF Working Papers 97/83, International Monetary Fund.
    4. Olivier Jeanne & Lars E. O. Svensson, 2007. "Credible Commitment to Optimal Escape from a Liquidity Trap: The Role of the Balance Sheet of an Independent Central Bank," American Economic Review, American Economic Association, vol. 97(1), pages 474-490, March.
    5. Alain Ize, 2005. "Capitalizing Central Banks," IMF Working Papers 05/15, International Monetary Fund.
    6. Luis Jácome & Eric Parrado, 2006. "The Quest for Price Stability in Central America and the Dominican Republic," Working Papers Central Bank of Chile 390, Central Bank of Chile.
    7. C.A. Sims, 1999. "The Precarious Fiscal Foundations of EMU," DNB Staff Reports (discontinued) 34, Netherlands Central Bank.
    8. Alain Ize, 2006. "Spending Seigniorage," IMF Working Papers 06/58, International Monetary Fund.
    9. Charles Goodhart, 1999. "Myths About the Lender of Last Resort," FMG Special Papers sp120, Financial Markets Group.
    10. Olivier Jeanne & Lars E. O. Svensson, 2004. "Credible Commitment to Optimal Escape from a Liquidity Trap," IMF Working Papers 04/162, International Monetary Fund.
    11. Alain Ize, 2005. "Capitalizing Central Banks: A Net Worth Approach," IMF Staff Papers, Palgrave Macmillan, vol. 52(2), pages 289-310, September.
    12. Peter Stella & Ulrich H. Klueh, 2008. "Central Bank Financial Strength and Policy Performance," IMF Working Papers 08/176, International Monetary Fund.
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    Cited by:
    1. Belke, Ansgar & Potrafke, Niklas, 2012. "Does government ideology matter in monetary policy? A panel data analysis for OECD countries," Journal of International Money and Finance, Elsevier, vol. 31(5), pages 1126-1139.
    2. Aleksander Berentsen & Alessandro Marchesiani & Christopher J. Waller, 2013. "Floor systems for implementing monetary policy: Some unpleasant fiscal arithmetic," ECON - Working Papers 121, Department of Economics - University of Zurich, revised Sep 2013.
    3. Jacome H., Luis I. & Saadi Sedik, Tahsin & Townsend, Simon, 2012. "Can emerging market central banks bail out banks? A cautionary tale from Latin America," Emerging Markets Review, Elsevier, vol. 13(4), pages 424-448.
    4. Martin Cincibuch & Tomas Holub & Jaromir Hurnik, 2008. "Central Bank Losses and Economic Convergence," Working Papers 2008/3, Czech National Bank, Research Department.
    5. Peter Stella & Ulrich H. Klueh, 2008. "Central Bank Financial Strength and Policy Performance," IMF Working Papers 08/176, International Monetary Fund.
    6. Martin Mandel & Vladimír Zelenka, 2009. "Central bank Losses. An Economic and Accounting Perspective Using the Example of the Czech National Bank," Politická ekonomie, University of Economics, Prague, vol. 2009(6), pages 723-739.
    7. Perera, Anil & Ralston, Deborah & Wickramanayake, Jayasinghe, 2013. "Central bank financial strength and inflation: Is there a robust link?," Journal of Financial Stability, Elsevier, vol. 9(3), pages 399-414.

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