Central bank independence and monetary policy-making institutions: Past, present and future

Two decades ago and earlier most central banks in the world functioned as departments of ministries of finance. By law, custom or both, they were expected to utilise their policy instruments to achieve myriad objectives such as high levels of growth and employment, provision of funds to government for the financing of public expenditures and to address balance of payments problems.1 They were also expected to maintain financial and price stability but the pricestability objective was one among several other objectives in the charter of the Bank and had no particular status. In some cases like Spain and Norway it did not even appear in the charter. Paralleling this state of affairs, economic theory did not attribute particular importance to central bank independence (CBI) and the concept of credibility of monetary policy was in the early stages of development. Furthermore, a notable legacy of the Keynesian revolution was the belief that a certain amount of inflation is conducive to economic growth. Although some banks had a reasonable amount of legal independence, the level of actual independence, particularly in developing countries, was usually lower than the one indicated in the law. Except for a few cases central banks did not possess instrument independence and the responsibility for price stability was, at least implicitly, located in the ministry of finance and other economic branches of government. In a few developed economies (such as the United Kingdom, Japan, the United States and West Germany) with wide capital markets, price stability was maintained mainly through the actions of relatively conservative treasury departments or because of de facto independent central banks.2.