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Issues in Central Bank Finance and Independence

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  • Åke Lönnberg
  • Peter Stella

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.

Suggested Citation

  • Åke Lönnberg & Peter Stella, 2008. "Issues in Central Bank Finance and Independence," IMF Working Papers 08/37, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:08/37
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    References listed on IDEAS

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    11. Jean Tirole, 2006. "The Theory of Corporate Finance," Post-Print hal-00173191, HAL.
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    Citations

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    Cited by:

    1. Ricardo Reis, 2016. "Can the Central Bank Alleviate Fiscal Burdens?," NBER Working Papers 23014, National Bureau of Economic Research, Inc.
    2. Aleksander Berentsen & Alessandro Marchesiani & Christopher Waller, 2014. "Floor Systems for Implementing Monetary Policy: Some Unpleasant Fiscal Arithmetic," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 17(3), pages 523-542, July.
    3. Stephen Quinn & William Roberds, 2016. "Death of a Reserve Currency," International Journal of Central Banking, International Journal of Central Banking, vol. 12(4), pages 63-103, December.
    4. Martin Mandel & Vladimír Zelenka, 2009. "Ztráta centrální banky - účetní a ekonomický pohled na příkladě České národní banky
      [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.
    5. Peter Stella & Ulrich H Klueh, 2008. "Central Bank Financial Strength and Policy Performance; An Econometric Evaluation," IMF Working Papers 08/176, International Monetary Fund.
    6. 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.
    7. Julien Pinter, 2017. "Central bank financial strength and inflation: an empirical reassessment considering the key role of the fiscal support," Documents de travail du Centre d'Economie de la Sorbonne 17055, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    8. Schwarz Claudia & Karakitsos Polychronis & Merriman Niall & Studener Werner, 2015. "Why Accounting Matters: A Central Bank Perspective," Accounting, Economics, and Law: A Convivium, De Gruyter, vol. 5(1), pages 1-42, March.
    9. Favaretto, Federico & Masciandaro, Donato, 2016. "Doves, hawks and pigeons: Behavioral monetary policy and interest rate inertia," Journal of Financial Stability, Elsevier, vol. 27(C), pages 50-58.
    10. 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.
    11. Martin Cincibuch & Tomáš Holub & Jaromír Hurník, 2009. "Central Bank Losses and Economic Convergence," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 59(3), pages 190-215, August.
    12. Jakob Korbinian Eberl, 2016. "The Collateral Framework of the Eurosystem and Its Fiscal Implications," ifo Beiträge zur Wirtschaftsforschung, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, number 69.

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    Keywords

    Central bank capital; Central bank independence; Central banks; Capital flows; Capital account; central bank; national bank; reserve bank; inflation;

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