The Central Banking and the Independence of Central Banks

The world have been living a very different era than before. This different era is the globalization. Globalization means that every happening in a country may affect another country. This is applicable both in trade and definitely in the finance sector. When we talk about the finance sector, the banks and the other financial intermediaries come to the mind. These intermediaries are operating under specific laws and regulations. These regulations are prepared by the governments and the banks which are named as the bank of banks. This bank of banks is the central bank. Central banks are very important institutions for the finance sector. Their importance is not coming only from their regulations that are prepared for the usage of an effective banking system but also from their decisions for the stability of the economy.

With this kind of understanding, we will be dealing with the central banking concept in this essay.  We will try to show their duties and their importance in the economy. After that the independence of central banks will be defined and we will try to analyze the importance of independence of the central banks for the goodwill of the economy.

Central Banking

Central Banks are the bank of banks. They are serving banking services for the other banks. If the banking environment has liquidity problem they provide liquidity, if the market has foreign exchange shortage they provide foreign exchange. This kind of an operating principle creates a buffer for the banking system incase of economic depressions. They are also acting as the price stabilitors in the economy. When we summarize their duties, we can indicate the following points:[1]

·         Open market transactions

·         Determination of discount rates

·         Reserve requirements

If there is a shortage of money in the economy, the rates may go high and the investments may be postponed. In these kinds of situations the central bank starts to buy Treasury bonds in order to increase the liquidity in the economy. Therefore the rates will no more go up and start to decrease. This operation is called the open market transactions. This is used in the immediate responses of the central bank and this is supposed to be the most efficient tool of this bank.[2]

The other tools are used for the long term requirement of the bank. The discount rates are related to the discount of the notes that were previously discounted by the banks. If this rate is increased, the banks will also increase the rates and this will generate a general increase in the prices of the loans.[3]

The last important tool is the reserve rates. Reserve rates state the ratio of the deposits which must stay at the central bank for security reasons. When the central bank want to decrease the loans in the market, it starts to increase the associated rate and the banks are forced to hold more money in the central bank.[4]

Independence of Central Banks

Before explaining the central bank independence we firstly define the independence concept. This means that while central bank is completing its responsibilities (such as trying to stabilize the prices in the market) they are supposed to be acting independently without the orders of the governments or other governmental institutions.[5] The word independence does not give the right to act against the regulations and laws predefined by the governments.

In order to give an example, we can state the political independence of Turkish central bank that can be seen from the following statements:[6]

• The central bank governor can not be appointed by the government.
• The central bank governor is appointed for more than 5 years.

• The board of the bank can not be appointed by the government.
• The board of the bank is appointed for more than 5 years.
• In the board there can not be found any government representative.
• In monetary policy determination process there is not government approval is required

Besides the above indications, there are two different ideas out the independence of the central banks. One group of economist is for the central bank independence and the others are against to this idea. The idea of defending the independence of this bank says that, if the central bank is under the political pressure, inflation is supposed to be occurred. This is mainly because of the short termed and populist policies rather than long termed plans. This short term decisions are taken in order to prevent the high unemployment and high interest rates. Due to this the government may want to increase the monetary supply to decrease the high interest rates in the short term. Nevertheless this may disappear after a short period of time and the next appearance of high interest rates may not be defeated like did before. Therefore the central banks that are acting independently are the main defenders of the price stability because they don’t have political concerns.[7] Further if the government needs money to pay the salaries of the officers or to make expenses for the other governmental issues, they may go to the central bank to force the bank to buy treasury bonds.  For an independent central bank this demand can be rejected without any reason.

The other idea which stands against to the independence, says that this may create a democracy gap. This is because of the superior authority of the appointed people compared to the elected people. The public selects its own deputies for the parliament in order to rule the country on behalf of them. Nevertheless the elected people can not manage the economy but the appointed people manage the central bank.[8]

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[1]Paul A. Samuelson, İktisat, İstanbul, Menteş, 1970, p.346-351.

[2] Başkent Üniversitesi, “Merkez Bankası”, http://www.baskent.edu.tr/~gurayk/finpazcuma4.doc.

[3] David Begg, Economics, İstanbul, Literatür, 1994, p. 408.

[4]Samuelson, p. 353.

[5]C.C.Aktan, S.Togay, U.Utkulu, “Merkez Bankası Bağımsızlığı: Terminoloji”, http://www.canaktan.org/ekonomi/merkez-bankacilik/terminolo.htm.

[6] Hakan Kum, Hayriye Atik, “Türkiye Cumhuriyet Merkez Bankası’nın Bağımsızlığı: Avrupa Birliği Ülkeleri İle Bir Karşılaştırma”, http://iibf.erciyes.edu.tr/akademik/kum/merkezbank.htm.

[7] Frederic Mishkin, The Economics of Money, Banking and Financial Markets, New York, Little, Brown, 1986, p. 333-334.

[8]Ali Bilge, “Merkez Bankası Bağımsızlığı”, http://www.isletme-finans.com/birgun/birgun59.htm.