Print Email Download Reference This Send to Kindle Reddit This
submit to reddit

Central Bank

Abstract

There has been a recent revival of interest in the academic literature on the function and echelon of transparency in Central Bank. The far and wide perceived trend towards greater transparency can, first, be related to decisive moves towards greater central bank independence. The other may related to the growing importance of financial market and private agents expectation. It is important to understand that higher transparency makes monetary policy more predictable as well as more effective and credible in achieving its goal. This paper focuses only on the different aspect of transparency in a central bank. In relation to this, this study explains transparency of Central Bank with different economic factors, for instance, financial strength of Central Bank, Interest rate indicator, market efficiency and some others.

Introduction

Escalating interest in financial transparency accompanied a prevalent adoption of rules-based macroeconomic policy frameworks in the early 1990s. The U.S. Budget Enforcement Act of 1990, the 1992 Maastricht Treaty (later to be followed by the Stability and Growth Pact's deficit and debt limits), and a movement toward transparency in New Zealand and Australia raised the profile of fiscal accounting, while pressure also increased to enhance the openness of monetary policy.

In this day and age, lots of countries have customary an independent central bank. The government delegates monetary policy to an independent institution that focuses primarily on price stability. By delegating monetary policy making to an independent central bank, the government can achieve a lower rate of inflation by tumbling the inflationary bias. This benefit of enhanced credibility comes at the cost of less elasticity in reacting to deliver shocks. However, there is an obvious risk in giving away control over monetary policy. There must be a apparatus that ensures that monetary policy is lay down in a way that is compatible with society's best focus. So transparency is a must. However, its clear from some other writings that different author belief the level of transparency is the indicator of overall monetary performance. Although rarely acknowledged explicitly, the financial strength of an independent and credible central bank must be matching with its policy errands.

This paper focuses on transparency of actual monetary policy. “Monetary policy is transparent if there is little uncertainty about the central bankers references. Transparency enhances the central bank's accountability” (Eijffinger, Hoeberichts and Sc, 1998). Another method to make the central bank accountable is to change final responsibility for monetary policy in the track of the administration. Today, as Issing (2005) says, there is a common consensus among central bankers that transparency is not only an obligation for a public entity, but also a real benefit to the institution and its policies. For a long time, however, central banks followed quite a diverse custom. Sometimes without knowing, sometimes quite deliberately—and very much in keeping with the prevailing zeitgeist—they evinced an air of discretion, to put it gently.

Literature Review:

The term “Transparency” is propped up by the empirical study that, indeed, transparency seems to mean different things to different people. It might seems true that the debate that transparency of the European Central Bank (ECB). Some critics (Especially academics) call for the release of more information on the range of views expressed in Governing Council meeting, the publication of computes and voting records. At the same time other commentators (People from financial markets) complain about the confusion arising from the slightest variation of emphasis in policy-makers' statement, when they do not sufficiently “sing from the same hymnbook”. In other words the ECB is talking a little for some and taking too much for the other.

The issue now is whether monetary policy outcomes are related to the degree of central bank ‘transparency' and this raises the inevitable question of how we measure transparency. The parallels continue. Blinder (2001) can be read as giving an account of transparency in the conduct of monetary policy in various central banks including the Federal Reserve, the ECB and the Bank of England, though there is no explicit definition and measurement. Fry (2000) do construct an index but this is based on survey responses which may be spoiled by what central bank officers would like their degree of independence to be. Chada and Nolan (1999) take the degree of transparency in UK policy making to have increased in recent years and observe that this is associated with increasing interest rate volatility. The increased volatility is not, however, explained by the increased transparency. By insinuation, concealment does not help stabilise interest rates. Most interestingly of all, Eijffinger and Geraats (2002) take an approach which is very similar to that of the independence literature by looking at the official documents relating to the conduct of a assortment of central banks.

The realistic expectations movement in macroeconomics, especially the regulations versus discretion literature, provided a theoretical basis for greater ingenuousness. Kydland and Prescott (1977) showed clearly that discretionary policy actions used to surprise economic agents were actually counterproductive for a central bank focused on price stability. Faust and Svensson (2001) also pointed out that policy actions that reveal a central bank's goals and intentions without formal communication may provide an alternative criterion for assessing transparency. A recent literature of Amato, Morris and Shin (2002) has highlighted the possibility that there are limits to transparency owing to the tendency of the public to overweight the signals provided by the central bank. A more pragmatic argument about limits emphasising the differences between transparency and clarity has been put forward by Mishkin (2004).

Supplementary communication confronts arise from consideration of the issues associated with the field of behavioural economics. But according to Akerlof (2006), while still in its infancy as an academic field and with only limited research applied to macroeconomic problems, it nonetheless suggests that not only does the amount of information matter but also the way the information is framed matters, too. There is still much to do before the full extent of the implications for monetary policy can be explored. While somewhat approximate, some conjectures might be rational.

In the analysis of Eijffinger, Hoeberichts and Sc, (1998), they have focused on two types of accountability: accountability through transparency and accountability through final responsibility. Transparency reduces the uncertainty about the central bank's preferences and can be achieved by publication of relevant information. For instance, publishing minutes of meetings and inflation reports that give a motivation for the actions that the central bank has taken increase the transparency of monetary policy. They also showed that, although transparency makes the region of independence smaller, effective central bank independence increases with transparency. This leads to a lower expected rate of inflation and less stabilization of productivity shocks. So, more transparency shifts the balance of credibility vs. flexibility in the direction of credibility. Therefore, achieving accountability through transparency is especially attractive for countries that face a serious credibility problem relative to the flexibility problem.

Guinigundo (2006) highlighted the following reasons for the trend toward greater transparency and better communication. First, the trend toward greater transparency and better communication was driven by monetary policymakers' increasing recognition that their policy actions would be more effective if the market understood them better. As Ehrmann and Fratzscher (2007) observed, “Central banks have direct control only over a single interest rate, usually the overnight rate, while their success in achieving their mandate requires that they are able to influence asset prices and interest rates at all maturities.” Effective communication as much as believable policy deeds is of basic importance for achieving central bank objectives. Second, the importance on transparency and communication was also spurred by the mounting interest in the greater accountability of central banks, as an growing number of them were accorded independence from political authorities. The accountability over money and banks by an unelected central bank could be reputable if it were to make its targets and policies better known to the general public. Finally, the getting higher popularity of inflation targeting, with its importance on the transparency and accountability of the central bank, has also provided additional energy towards improving the disclosure and openness of central banks. Inflation targeting as a framework attempts to establish an explicit link between monetary policy conclusion and the central bank's review of potential inflation, and thus chairs a weight on the release of timely information about the views of the central bank on the inflation outlook.

Very recent study of Stella (2005) indentifies central banks tend to have very different financial results, as well as different levels of accounting capital. One reason for this, which makes crosscountry comparisons difficult, is wide variation in accounting practices, as well as limited transparency. Again, Stella (2003) provides internationally comparable data on “other items net” as a proportion of central bank assets and demonstrates both a very wide range and high levels of this index, which he interprets as a transparency proxy.

Most upsetting are central banks not subject to effective external audit, whose accounts lack integrity and are not dispersed. This makes external oversight difficult—a situation not undesired at sure times by certain governments that, to have a loan of from the language of Fry, Goodhart, and Almeida (1996), are quite content to hide the fact that they are squeezing the goose that lays the golden eggs.

With these fore warnings in mind, it must be noted that a great deal of improvement in the basic accounting framework and in transparency has been made in the past decade, include:

• International Monetary Fund (IMF) has urbanized norms and a code of good practices on transparency in fiscal and monetary and financial policies, using them to review the policies of dozens of member countries to date.

• Amendment to International Accounting Standards (IAS) applicable to financial institutions have been made. For example IAS 39 “Financial Instruments: Recognition and Measurement,” which broadens the application of fair value accounting, became effective January 1, 2001.

• The IMF has exertion with member countries to improve their transparency as proof by technical assistance and seminars as Sullivan (2005). According to them, explicitly discusses the applicability of IFRS to central bank accounting as Courtis and Mander (2003) identified.

• The uphold assessment observe the adequacy of five key areas pertaining to the central bank: external audit, internal audit, legal independence, financial reporting, and internal controls. An essential obligation is that countries publish annual central bank financial statements that are independently audited in accordance with internationally accepted standards.

• The Fund has completely revised its fundamental fiscal accounting framework with the introduction of the 2001 Manual on Government Finance Statistics (IMF, 2001c) to bring it in line with the UN's System of National Accounts and to address concerns raised over the years (the previous edition dated from 1986).

Despite this momentous progress, individual country improvements have been infrequent. IMF safeguard assessments have identified a number of problems that have been or are being addressed in the central banks assessed, but these constitute only a subset of member countries. In particular, 88 percent of assessed central banks were identified as having had inadequate accounting standards

Finally, Rafferty and Tomljanovich (2002) argue that open public disclosure of central bank policies may improve the efficiency of markets. We examine this claim by studying whether the Federal Reserve System's 1994 policy shift toward more open disclosure improved or worsened the predictability of financial markets. Employing methods analogous to Campbell and Shiller (1991), we find that since 1994, the forecasting error has decreased for interest rates on U.S. bonds of most maturity lengths, and that the expectations hypothesis has performed better at the low end of the yield curve. These findings are inconsistent with the view that increased central bank transparency will decrease the efficiency of financial markets.

Analysis:

Rightly or wrongly, there is a widely-held view that transparency in the conduct of monetary policy is a first-rate thing: it makes guidelines more effective and policy objectives can be accomplished at lower cost. It is hardly surprising, therefore, that the degree of transparency attaching to the conduct of central banks has been the subject of considerable study.

The sustained growth in private capital stream to budding markets, the Asian and Russian crises, and the materialization of calls for a new international financial architecture accelerated an already evident trend toward superior transparency in the accounts of governments, central banks, and the financial division. Unadventurous wisdom now stresses the importance of information revelation for the functioning of markets and for the reduction of risk premiums for sovereign borrowers. There is as well a strong conviction that as Kopits, George ed., (2004) saya “. . . credibility of fiscal rules and objectives is strengthened if such measures are accompanied by enhanced fiscal transparency, as this openness complements a rules-based approach in three ways: by removing any tendency to be non-transparent to meet rules; by facilitating judgments of actual fiscal performance against rules, which makes transparency an essential requirement for rules to be effective; and by allowing justifiable flexibility in the application of rules.” As Kopits (2001) points out, “. . . the usefulness of fiscal rules hinges on transparency in institutional structure and functions, that is, in the relations within the public sector.” Central banks, however, in their financial or fiscal operations have historically been very opaque and a prime locus for non-transparent quasi-fiscal operations.

As you would have thought, the degree of transparency lays upon a variety of institutional arrangements peculiar to each monetary regime. Thus, the dominant approach to measurement relies upon identifying a range of legal and other formal characteristics - in a manner very reminiscent of the central bank independence literature of fifteen years ago. This approach is not entirely satisfactory, however, since it is agents' perceptions of the degree of transparency that matters if transparency is to have any effect on policy outcomes. This has given rise to other methods of measurement which survey the views of agents. While this is potentially more relevant, it is obviously possible that their statements may differ from their actions.

Summary:

It is extensively supposed that monetary policy outcomes are generally improved if the conduct of policy by the central bank is widely understood by other agents in the economy. This widespread belief has given rise to a number of attempts to measure the ‘transparency' of monetary policy in various regimes. Apart from the straightforward infeasibility of certain policy commitments when they violate the central bank's inter-temporal budget constraint, a less severe degree of weakness decreases the central bank's credibility and worsens the policy cost/benefit trade-off. This would be the case where the current constellation of exogenous factors is consistent with the chosen policy but the central bank would not be able to withstand potential shocks to its balance sheet. Here I agree with the statement of Blejer, Mario and Schumacher. (1998) that “what is relevant is not so much the consistency of the transparency but its vulnerability and the possible volatilities of certain variables that would affect central bank strength and correspondingly its ability to fulfill its policy obligations”.

So, the better is central bank financial self-government—by definition—the larger is its aptitude to withstand shocks without recourse to fiscal or quasi-fiscal resources. An additional issue is that central bank concern with its balance sheet, even though not vulnerable, could lead to a policy reversal. Hence the importance of choosing the right measure of target level of transparency.

Conclusion:

The quest for absolute, unlimited transparency about the decision-making process thus quickly runs into practical difficulties. By contrast, the case for publishing facts and s seems to be a fairly straightforward one—or at least at first glance. But, even here, transparency can hardly be tantamount to an obligation to publish everything immediately. What stands in the way of such an approach is the sheer volume of information that would be unleashed, running the risk of blocking the communication channel and overwhelming recipients. A strict interpretation of a comprehensive notion of the requirement for disclosure could indeed allow an agent—and this is not just a hypothetical consideration—to use communication to deliberately orchestrate an information overflow in order to act essentially unobserved behind a veil of staged confusion.

All of these suggest that the notion of transparency has different and potentially conflicting aspects to it. In the very first phase, narrow, notion of transparency as the amount and precision of information that is released will be referred to as openness in the remainder of the paper. However, openness is not by itself sufficient for achieving transparency, when the letter is defined more broadly as a measure of genuine understanding and hence. The second element of transparency refers to the degree of clarity in the presentation and the interpretation of the information. The implied optimal level of transparency will differ across different agents and across different result oriented problem.

References:

Akerlof, G. (2006). The missing motivation in macroeconomics, American Economic Review, March.

Briault C., A. Haldane and M. King (1996). Independence and Accountability, Proceedings of the Seventh International Conference sponsored, Institute for Monetary and Economic Studies, 26-27

Eijffinger, Sylvester C.W.Hoeberichts, Marco and Sc Eric (1998). A Theory of Central Bank Accountability, Center for Economic Research, Tilburg University

Stella, Peter (2005). Central Bank Financial Strength, Transparency, and Policy Credibility, International Monetary Fund Staff Papers, Vol. 52, Number 2.

Stella, Peter (2003). Why Central Banks Need Financial Strength, Central Banking, Vol. 14 November.

Kopits, George ed. (2004). Rules-Based Fiscal Policy in Emerging Markets: Background, Analysis and Prospects, New York: Palgrave Macmillan Ltd.

Kopits, George (2001). Fiscal Rules: Useful Policy Framework or Unnecessary Ornament? IMF Working Paper 01/145 (Washington: International Monetary Fund).

Mackenzie, George A. and Peter Stella (1996). Quasi-Fiscal Operations of Public Financial Institutions, IMF Occasional Paper No. 142, Washington: International Monetary Fund.

Blejer, Mario I., and Adrienne Cheasty, eds., (1993). How To Measure the Fiscal Deficit: Analytical and Methodological Issues,Washington: International Monetary Fund.

Courtis, Neil, and Benedict Mander, eds., (2003). Accounting Standards for Central Banks, London: Central Banking Publications.

Sullivan, Kenneth (2003). Profits, dividends and capital—considerations for central banks, in Accounting Standards for Central Banks, London: Central Banking Publications.

Blejer, Mario I., and Liliana Schumacher (1998). Central Bank Vulnerability and the Credibility of Commitments: A Value-at-Risk Approach to Currency Crises, IMF Working Paper 98/65,Washington: International Monetary Fund.

Rafferty, Matthew and Tomljanovich, Marc (2002). Central Bank Transparency and Market Efficiency: An Econometric Analysis, Journal Of Economics And Finance, Volume 26, Number 2.

Blinder, Alan S., Charles A.E. Goodhart, P Hildebrand, D Lipton and Charles Wyplosz (2001). How do Central Banks Talk?, Geneva: International Center for Monetary and Banking Studies.

Guinigundo, D. (2006). Monetary policy in a time of uncertainty, remarks at IMF regional seminar on central bank communications, Mumbai, January.

Ehrmann, M. and M Fratzscher (2007b). Transparency, disclosure and the Federal Reserve, International Journal of Central Banking, March.

Mishkin (2004). Can central bank transparency go too far?, in The Future of Inflation Targeting, Reserve Bank of Australia conference proceedings

Kydland, F and E Prescott (1977). Rules rather than discretion: the inconsistency of optimal plans, Journal of Political Economy, June.

Issing Otmar (2005). Communication, Transparency, Accountability: Monetary Policy in the Twenty-First Century, Federal Reserve Bank of St. Louis Review, Part 1. 65-83.

Print Email Download Reference This Send to Kindle Reddit This

Share This Essay

To share this essay on Reddit, Facebook, Twitter, or Google+ just click on the buttons below:

Request Removal

If you are the original writer of this essay and no longer wish to have the essay published on the UK Essays website then please click on the link below to request removal:

Request the removal of this essay.


More from UK Essays

Doing your resits? We can help!