Submitted By :- Niharika Singh (2) Sneha Raina (9) Aditi V.Jain (10) Animesh Hakim (17) Jeevan Rajan (20) Priyanka Chauve(24) Pranav Jain (43)

AUTONOMY OF CENTRAL BANK

In 1926 -Hilton Young Commission recommended divisions

of responsibilities for control of currency and credit should

end.

Bill to establish RBI was introduced in 1933

The RBI Act came into force on January 1, 1935

The RBI was inaugurated on April 1, 1935 as a

shareholders’ institution and the Act provided for the

appointment of the Governor and two Deputy Governors.

RBI was nationalized on January 1, 1949 in terms of the

Reserve Bank of India (Transfer to Public Ownership) Act,

1948

History Of Central Bank

Termination of the system of automatic

monetization

Issues of transparency and accountability

governing operations

Draft legislations by RBI during the same period

Introduction

Central banking and its independence in

measuring autonomy

Indian experience through recourse to

periodisation

Emerging issues in India

Three focus areas

Creation of Money or monetary management

Management of public debt of government

Regulation and supervision of banking entities

Financing of developmental activities

Functions of Central Banking

Function of debt management and autonomy(No autonomy)

Regulation and supervision(Same as other bodies)

Developmental role (Central bank and government)

Political power and limitation on credit to government Napoleon Bonaparte commented in 1806, on Bank of

France; “I want the bank to be in the hands of the Government, but not too much”.

Functions and autonomy

Personal matters: Appointment, term of office and

dismissal procedures of top central bank officials

Financial aspects: The extent to which

govt.expenditure is either directly or indirectly

financed via central bank credits

Conduct of policy: Flexibility given to the central

bank in the formulation and execution of

monetary policy

Central Bank Independence

Goal independence refers to a situation where the

central bank itself can choose the policy priorities of

stabilizing output or prices at any given point of time,

thus setting the goal of monetary policy

Instrument independence implies that the central bank

is only free to choose the means to achieve the

objective set by the government.

Most banks define independence only in terms of

Instruments

Goal and Instrument independence

Time inconsistency theory

Time inconsistency arises when the best plan currently made

for sure future period is no longer optimal when that period

actually starts.

In the context of monetary policy the time inconsistency

problem arises because there are incentives for a politically

motivated policy maker to try to exploit the short run trade-off

between employment and inflation.

Example: Expansionary monetary policy

Theories

Conservative central bank approach: It postulates the appointment of a conservative central banker whose aversion to inflation is well known which would result in low inflation because of the economic agents belief in the reputation of the central banker. Example: Unites States

Optimal contract approach: It postulates the existence of an optimal contract between the central banker and the government. The central banker’s tenure in office is conditional upon his performance of achieving low inflation, failure of which would lead to the repudiation of the contract of tenure. Example: New Zealand

Two Corrective Approaches

THE POLITICAL BUSINESS CYCLE THEORY

◦ Studies the interaction between economic

policy decisions and political considerations.

◦ The business cycle mirrors

◦ The timetable of the election cycle

Theories

THEORY OF PUBLIC CHOICE

◦ Constitutional amendment for a pre-specified

stipulation on central bank credit to government

◦ Fusion of politics and economics

◦ Theorist’s view : Politicians do not necessarily

pursue public interest but are more concerned

with their personal or political agenda.

Theories

Independent central bank lacks democratic legitimacy

Milton Friedman “ money is too important an issue to be left to the whims of central bankers

Independence may lead to frictions between the fiscal and monetary authorities which may be somewhat costly for society, thus inhibiting the development process.

Significant divergence in the preference pattern of independent central banks and the society at large

Arguments against central bank autonomy

Informal arrangements with governments

The quality of the personnel in the bank as

well as Government and the personal

characteristics of key individuals

Legal Independence:

◦ Indices of political and economic independence

◦ Frequency of transfers of central bank governors

Degree Of Independence

Negative correlation between Central Bank Autonomy & Inflation

Bi-directional: Since it is argued that persistent high inflation led to changes in the operational and legal framework

Central Bank’s Autonomy cannot ensure monetary policy credibility, which also depends on credibility of government policy

Autonomy is a means to achieve division of responsibility between monetary & fiscal authority and policy co-ordination

Central bank independence & Economic performance

Infancy/Uncertainty Phase (1927-1948) Legislation to set-up in 1927, enactment in 1934; RBI set up

as a privately owned / managed entity focused on monetary stability and operations on currency and credit system

Subservient to the dictates of the Government; measures taken to curb its board from taking independent actions

Maturing into a full-fledged Central Bank (1948-1969)

Good fiscal rectitude and harmony in monetary and fiscal policy

Modest rate of inflation, success of macro-policy management facilitated RBI in pursuing other developmental activities

Institutionalisation of credit to agriculture and industry in pursuant to the objectives of Five-Year Plans

Four Distinct Phases of RBI - Government Relationship

From Owners to Supervisors (1969-1990)

Nationalization of banks Transfer of ownership leading to a state of Captive market

for the Government For easy access of market borrowing, administration of key

interest rates, SLR, CRR periodically revised

During this period there were some areas of conflict with Government, these involved

Physical planning subduing financial planning was disapproved

Differences over Interest rate policies, Deficit financing, corporate credit policies, management of sub-standard banks

Four Distinct Phases of RBI - Government Relationship

Opening the markets with Reforms (1990 onwards)

Severe balance of payments crisis in the beginning

Abolition of Ad Hoc T-Bills Opening up of economy through clearer

articulation of policy goals Moderate rate of inflation inspite of high Fiscal

deficit Financial reforms including strengthening of

banking supervision

Four Distinct Phases of RBI - Government Relationship

In an approach towards redefining the functions of the

RBI and enabling a movement towards meaningful

autonomy there were some considerable steps taken

Divestment of RBI from all ownership functions in

commercial Banking, development finance & security

trading

Separation of Government Debt management from

monetary policies enabling RBI’s role to primarily focus

on monetary policies & move towards greater

autonomy

Current Status

At the level of constitution

Only few references to autonomy of Central Bank

in the constitution

At the level of legislative framework

Proposed fiscal responsibility, budget

management bill and other amendments in RBI act

Suggestions of advisory groups and internal

committees

Emerging Issues

At the Policy Level Fiscal dominance warranting large

involuntary financing of credit by RBI Underdeveloped state of Financial markets

partly due to legal & institutional constraints blunts the effectiveness of Monetary policy

At the operational & procedural level Considerable scope to reduce micro

management issues The approach basic tenets of accounting

principles in regard to transactions between RBI & Government

Emerging Issues