Since the 2007–08 financial crisis, when central banks saved the global economy through strong, concerted (though belated) action, they have gained an ever higher profile as guardians of economic policy, both nationally and internationally.
Controversies in the past few months surrounding central banks in India and in my own country, Nigeria, have sharpened the debate over the independence of reserve banks. Tensions over central banking stewardship have emerged in other countries, including Argentina, Hungary, Malawi, Mauritius, Venezuela and Zambia.
In India, the independence of the Reserve Bank of India and its governor, Raghuram Rajan, was perceived to be threatened when the Indian government proposed that its nominees form the majority on a new monetary policy committee. The matter was resolved with an agreement to establish a committee with equal representation from the RBI and the Indian government, but with the governor holding the casting vote.
Unlike India, the Central Bank of Nigeria for many years has had a formal 12-member MPC consisting of the governor, four deputy governors, and seven other outside members, including the permanent secretary of the finance ministry. I was one of these deputy governors between 2009 and 2014.
The reason for this balance of internal and external members is to ensure the CBN remains independent in monetary policy, while involving other knowledgeable outside experts. All MPC members vote individually on decisions, based on their own assessment of economic data and the macroeconomic situation.
Central banks should think and act rationally in the longer-term national economic interest, even if their decisions may be politically unpopular in the shorter term. They should not be influenced by politicians eying the election cycle. Where institutions are weak, vested political or commercial interests can easily bend them to the service of sub-optimal agendas or misguided notions of ‘national interest’.
‘External interference’ is usually understood to stem from governments. But central bank independence must also mean independence from other forces. These include economic agents such as commercial or investment banks, and even foreign portfolio investors.
Independence makes central banks more effective in carrying out their functions, particularly managing inflation and maintaining price stability. This is in the best interests of governments and their citizens.
Nowhere has this been more evident than in Africa, where inflation in the 1980s averaged 25% but independent central banks have since helped improve macroeconomic stability. Central bank independence is a significant factor in sovereign ratings and assessments of a country’s broader governance and institutions, as is the independence of the judiciary.
In Nigeria, the CBN’s independence – stipulated in the central banking act of 2007 – enabled it to bring inflation down to single digits and undertake far-reaching banking reforms after the 2007–08 crisis. The prior absence of this independence contributed to the country’s lacklustre economic performance in the 1990s.
Requiring external political approval for necessary measures, the bank frequently acted inadequately and too late. It failed to rein in politically connected fraudsters in the banking industry, resulting in failed banks that wiped out the savings of many Nigerians.
There are some contradictions between central bank independence and elected governments’ political legitimacy. A state institution, and the officials appointed to work in it, cannot be completely decoupled from the larger apparatus and activities of the state.
An enlightened political leadership must recognise the national interest of respecting the central bank’s operational and administrative independence, though this can never be absolute. Egregious malfeasance or spectacular incompetence can create exceptions. There are strong mechanisms for accountability in Nigeria, as in most other democracies.
Central banks should defend their independence when required but remain above the political fray to maintain their legitimacy. They must avoid the twin extremes of becoming, on the one hand, an ‘errand boy’ for politicians, and on the other a noisy ‘opposition party’ to a democratically elected government. A central bank that assumes either of these roles has lost its way.
Instead, whether in a crisis or in calmer times, central banks must display a sense of responsibility, combined with intellectual depth, long-term thinking, and political and economic sure-footedness. That is the way forward, for Nigeria and for all other democracies.
- Prof. Kingsley Moghalu is a former deputy governor of the Central Bank of Nigeria and a member of the OMFIF Advisory Board. He teaches international business and public policy, and is a Senior Fellow in the Council on Emerging Market Enterprises, at The Fletcher School of Law and Diplomacy at Tufts University, Boston.