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Issues in Central Bank Finance and Independence

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  • Ã…ke Lönnberg
  • Peter Stella
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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 government. While a long line of literature has emphasized the dangers of fiscal dominance influencing the conduct of monetary policy the idea that an independent central bank could be constrained in achieving its policy objectives by its own balance sheet situation is a relatively novel idea considered in this paper. 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 maintaining 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 and/or forcing them to abandon policy objectives.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 08/37.

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    Length: 41
    Date of creation: 01 Feb 2008
    Date of revision:
    Handle: RePEc:imf:imfwpa:08/37

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    Keywords: Capital flows; central bank; central banks; national bank; reserve bank; inflation; monetary fund; monetary policy; european monetary institute; sovereign debt; government debt; reserve currencies; monetary theory; monetary base; domestic debt; monetary income; monetary liabilities; public finance; public debt; treasury bonds; monetary reserves; debt service; monetary reserve; discount rate; reserve holdings; long-term debt; domestic currency; monetary integration; debt sustainability; monetary system; monetary stability; monetary stabilization; eurodollar market; monetary financing; monetary authorities; independent monetary policy; money market; reserve requirements; monetary authority; money supply; monetary regimes; monetary authority of singapore;

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    References

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    1. Olivier Jeanne & Lars E. O. Svensson, 2004. "Credible Commitment to Optimal Escape from a Liquidity Trap," IMF Working Papers 04/162, International Monetary Fund.
    2. Eric Parrado & Luis Ignacio Jácome, 2007. "The Quest for Price Stability in Central America and the Dominican Republic," IMF Working Papers 07/54, International Monetary Fund.
    3. 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.
    4. Alain Ize, 2006. "Spending Seigniorage," IMF Working Papers 06/58, International Monetary Fund.
    5. Goodhart, Charles A E, 1999. "Myths about the Lender of Last Resort," International Finance, Wiley Blackwell, vol. 2(3), pages 339-60, November.
    6. G. A. Mackenzie & Peter Stella, 1996. "Quasi-Fiscal Operations of Public Financial Institutions," IMF Occasional Papers 142, International Monetary Fund.
    7. Alain Ize, 2005. "Capitalizing Central Banks," IMF Working Papers 05/15, International Monetary Fund.
    8. Alain Ize, 2005. "Capitalizing Central Banks: A Net Worth Approach," IMF Staff Papers, Palgrave Macmillan, vol. 52(2), pages 289-310, September.
    9. Peter Stella, 1997. "Do Central Banks Need Capital?," IMF Working Papers 97/83, International Monetary Fund.
    10. Charles Goodhart, 1999. "Myths About the Lender of Last Resort," FMG Special Papers sp120, Financial Markets Group.
    11. C.A. Sims, 1999. "The Precarious Fiscal Foundations of EMU," DNB Staff Reports (discontinued) 34, Netherlands Central Bank.
    12. Alfred Broaddus & Marvin Goodfriend, 1996. "Foreign exchange operations and the Federal Reserve," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 1-20.
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    Cited by:
    1. 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.
    2. 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.
    3. Ansgar Belke & Niklas Potrafke, 2011. "Does Government Ideology Matter in Monetary Policy?: A Panel Data Analysis for OECD Countries," Discussion Papers of DIW Berlin 1180, DIW Berlin, German Institute for Economic Research.
    4. Peter Stella & Ulrich H. Klueh, 2008. "Central Bank Financial Strength and Policy Performance," IMF Working Papers 08/176, International Monetary Fund.
    5. 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.
    6. Martin Cincibuch & Tomas Holub & Jaromir Hurnik, 2008. "Central Bank Losses and Economic Convergence," Working Papers 2008/3, Czech National Bank, Research Department.
    7. 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.

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