Financial autonomy is crucial for 74% of BCs, says IMF – 03/18/2024 – Market

Having financial independence is crucial for the effective autonomy of a Central Bank for almost 74% of monetary authorities around the world, according to research by the IMF (International Monetary Fund).

This is the opinion of 64 of the 87 representatives who participated in the survey.

In the discussion text, published in mid-February, authors Tobias Adrian, Ashraf Khan and Lev Menand developed a new methodology to measure the characteristics that govern the actions of central banks in order to reinforce autonomy over decisions related to monetary policy.

The study has been circulating in the National Congress at a time when the president of the BC of Brazil, Roberto Campos Neto, publicly supported the approval of the PEC (Proposed Amendment to the Constitution) that gives financial and budgetary autonomy to the institution. The operational autonomy of the monetary authority has been in effect since February 2021.

In an interview with SheetCampos Neto said that more than 90% of the world’s central banks with operational autonomy also have budgetary independence.

“What we’ve been doing here is really thinking about best practices. Having this budgetary autonomy, we think is a key characteristic of independence. This would include proposing, approving and suspending budgets annually,” he tells Sheet Tobias Adrian, financial advisor and director of the Monetary and Capital Markets department at the IMF.

Appointed as one of the main staff at the IMF – before joining the fund, he was vice-president of the New York Fed (Federal Reserve) –, Adrian has focused on the topic in his studies.

According to him, academic literature shows the correlation between autonomy and effective results in central banks. However, he considers that some issues, such as budgetary independence, received less attention in previous analyses.

Knowing the extent to which a central bank can determine the salaries of its employees, he says, is an important aspect.

“We have seen examples where weakening budgetary autonomy can lead to bad results,” he adds. In his view, “a lack of independence can lead to dangerous macroeconomic outcomes.”

To prepare the new index, the study combined information from the IMF databases on Central Bank legislation (CBLD) and on monetary operations and instruments (MOID) – which govern 151 monetary authorities – and empirical research made with central bankers and senior representatives of the institutions.

The index encompasses ten metrics, including political independence of central bankers in relation to the Executive Branch, assessment of loans authorized by monetary authorities to governments and financial and budgetary autonomy of institutions.

Of the 193 monetary authorities approached to assess the weight that should be given to each variable globally, 87 responses were obtained, including from representatives of three monetary unions (Central Bank of West African States, European Central Bank and Central Bank of the Eastern Caribbean ). The weighting varied on a scale of 0 to 5, from the least to the most important subject.

Even though the research included the participation of BCs from five regions of the world, with different income levels and different types of markets, advanced economies ended up overrepresented.

In addition to the majority assessment regarding financial autonomy, the survey showed that 68% of participants see it as essential that control bodies be restricted to supervising the operational efficiency of the monetary authority, without the power to influence decisions related to monetary policy.

Additionally, for 62% of those interviewed, it is crucial that the president of the Central Bank is independent of the Executive Branch.

In this context, Adrian highlights the importance of the mandates of the president and directors of the BC not coinciding with that of the head of the Executive and the need for legal protections in this regard.

The IMF director highlights that the BC, whose main objective is to maintain low inflation and price stability, may eventually make decisions that the government is unhappy with. Therefore, in the event of political interference, financial stability and even debt sustainability in some countries may be compromised.

“This independence really proved to be a key concept for the success of central banks,” he says.

The new methodology, according to the authors, produces lower scores (on a binary basis, 0 or 1) regarding the independence of central banks compared to previous academic studies. This is because it is not allowed to use partial credit in the new index, and an institution can only score if a series of requirements are met.

“By structuring the variables more rigorously than previous indices, we do not credit central bank laws that appear to offer officials decision-making independence in some respects, but contain gaps that make the independence generated by these characteristics illusory,” says the text .

According to the researchers, the majority of central banks scored zero on multiple statutory characteristics associated with greater decision-making autonomy. “More than half of the sample lacks independence in six of the ten metrics,” states the study, without detailing which ones.

Adrian recognizes that legislation may not be strictly necessary or sufficient for a central bank to be, in fact, independent, as some countries have weaknesses in the legal framework, but have effective practices, while others have “strong” laws and weaker actions. .

“The problem is that policy may change in the future, and at that point there is no legal protection. Now, of course, if the courts don’t enforce the laws, there is also a problem. In that sense, it’s a little more subtle than than just looking at the laws”, he says.

The authors are working on a complementary study in which they will provide new classifications based on sections made by region and income level, involving parameters such as inflation, economic growth and employment.

In Brazil, defenders of expanding the BC’s autonomy have used the IMF’s discussion text to encourage the debate on the PEC in Congress by presenting comparative information on how the autonomy of BCs works in other countries.

Despite the government’s resistance to the proposal, the expectation is that it will be possible to hold the debate within Congress, even in an environment of difficulty for the PEC to advance without support from the government base in an election year.

Discussions about the BC’s degree of autonomy take place at a time of crisis in the Brazilian BC with the loss of civil servants in a period of years without new public competitions.