No independence without accountability

Mainstream economics literature has converged on the idea that central bank policies should be immune from public oversight to avoid being politicized. At the last annual dinner of the Bank of Mauritius (BoM), Governor Ramesh Basant Roi had the political fortitude to open up a debate on the issue of central bank independence, but surprisingly, he devoted no space to governance and accountability. For central banks, posits Professor Otmar Issing, a former member of the Executive Board of the European Central Bank, “accountability is the reverse side of the coin of independence.”

In the view of Mr Basant Roi, the history of central banking in Mauritius can be divided into two periods with the Bank of Mauritius Act 2004 as the cut-off point. Before that, “the Bank’s ability to pursue an independent monetary policy was severely constrained”, and “the Bank was required to seek the nodding approval of the Minister on many policy matters. Obviously, the Bank was not an independent organization.”

The BoM became legally independent in 2004. Thereupon, affirmed the Governor, “the Mauritian economy has had ten years of enduring stability in the domestic foreign exchange market. We often take this for granted and insult the man, the institution that gave the country this precious gift of stability.” Was this man Mr Basant Roi? The fact is that, from 2007 to 2014, Governor Bheenick received insults from those who lashed out against his monetary policy.

Among the various press articles that Mr Basant Roi wrote in that period, the one entitled “A Short Non-Technical Perspective on Central Bank Independence and BoM Monetary Policy Committee” demonstrated in no uncertain terms that “the Bank of Mauritius has lost its independence. It’s a sorry state of affairs – to see a central bank so discredited by a ministry of Finance”.

Indeed, Governor Bheenick felt compelled to put into place an Operations Reserves Reconstitution with a view to containing the appreciation of the rupee. Still, he was held responsible for the strengthening of the currency, and at the last year’s annual dinner, Governor Basant Roi stressed that “for quite some years in the past we have had a strong rupee.” How can he now boast about a supposedly “enduring stability” of the rupee at that time?

In the same vein, he remained silent on the Exchange Rate Support Scheme. One can understand that this Scheme was not his doing. Far from being a testimony of a stable foreign exchange market, it is actually a factor of instability and is not conducive to the development of “a full-fledged market based financial services industry in Mauritius”. It is important, says MCB Focus, “to revert to a single exchange rate mechanism in line with internationally-advocated norms pertaining to the adoption of simple and market-based currency practices.”

Governor Basant Roi concluded his address on an apologetic tone: “I have done what could possibly be done to maintain the independence of the Bank.” The statement sounds like failure. In practice, the BoM is not as independent as he wants us to believe.

The main argument supporting central bank independence is that governments typically run deficits as public spending is popular and taxes are politically unpopular. If fiscal authorities were given direct control over monetary policy, deficits would be financed largely by the creation of new money, for it is easier to hide the effects of money expansion than those of taxation. There is a connection between the central bank and government spending.

The layman is not aware that the monetary base, which comprises currency in circulation and deposits of depository corporations with the central bank, almost tripled over nine years, from Rs 28 billion in 2007 to Rs 82 billion in 2016! One rupee of budget deficit appears to be funded by 55 cents of additional monetary base. The BoM funds a large portion of the public deficit by producing more money that is put into loan markets to drive interest rates down.

So even a politically independent central bank does not provide a reliable protection against the insatiable credit appetite of government as the former can easily turn on the printing presses to keep the latter afloat. Should the BoM then be totally independent of any external constraint? An all-powerful central bank too can be destabilising and harmful to economic growth because any organisation without check and balance cannot possibly work well.

After all, central bankers are human monetary central planners who lack the incentives and information to supply the optimal amount of money to the banking system. With respect to monetary policy, fixed rules are better than discretion.

Provided that they are monitored with clearly defined rules, central banks can be fully free and independent in taking decisions related to their limited mandate. Governance mechanisms are also needed to assure that they are not unduly influenced by the banking industry or by any special interest group, but that they pursue the public interest. In a democracy, it is the interests of the people that the institution must serve. Basic democratic principles imply that society chooses the goals, and these will be accomplished if the policymakers are politically accountable and transparent.

The only well-specified objective that a central bank should achieve is about inflation rate. As rightly pointed out by Professor Issing, the basis for central bank independence “requires a consensus that price stability is a common good that should not be and must not be subject to the normal kinds of trade-offs and value judgements that are the domain of the regular political process.” He added that “if monetary policy were instead to be called upon to serve a multitude of – usually competing – goals, the status of independence would be both much harder to justify, and the related accountability much more difficult to achieve.”

The BoM monetary policy committee persists in trading off inflation for growth. Such an approach has not made it credible to the public. And nobody would trust an unaccountable Bank of Mauritius.