Just when the heat on the Central Bank of Nigeria (CBN) Governor, Godwin Emefiele was approaching its zenith, President Muhammadu Buhari spoke out in support of the policies to defend the value of the naira. More recently, Vice President Yemi Osinbajo attracted attention for saying, “Restrictions are definitely short term. There is no question about that” before adding, “So, long term, we expect that the CBN will ease restrictions as we go along.” These comments have generated constant chatter as they are suggestive of a government that has undue influence over its central bank.
This prompts the question – has the CBN lost its autonomy?
Most mainstream economists are in agreement over the virtues of central bank independence – the ability of the central bank to set objectives and pursue policies to fulfill these objectives, without government interference. This is a crude definition of independence and there are different degrees (goal independence, legal independence etc) but the idea will suffice here.
The argument for central bank independence comes from the purpose behind a central bank. Generally, central banks are created to regulate the money supply and supervise the financial system in order to ensure price stability and by extension, macroeconomic stability.
So how does central bank independence encourage price stability? Well, as explained by Milton Friedman, governments have an inflation bias due to the tradeoff they face between unemployment and inflation*. If they can increase the money supply in order to generate higher than expected inflation, they can boost employment and output in the short run. The easiest way to do this would be to get the central bank to discreetly print more money. This introduces the possibility of politically induced business cycles where monetary policy is used to boost short term output in order to improve political capital. John Maynard Keynes put it this way: “The inflationism of the currency systems of Europe has proceeded to extraordinary lengths. The various belligerent Governments, unable, or too timid or too short-sighted to secure from loans or taxes the resources they required, have printed notes for the balance.” An independent central bank that is mainly concerned about inflation (a conservative central bank) will be able to counter this bias and ensure price stability.
The problem is that independence alone does not solve this problem. An independent central bank with interests aligned to the government will do no better. This is one of the claims that has been lodged against CBN Governor, Godwin Emefiele as he has been accused of being a puppet of the new administration. Thus, central bank independence is not sufficient for price stability.
Nevertheless, independence has proven vital to macroeconomic stability in the last 50 years. It has prevented many countries from just printing money (for example, to pay off their debts – one of the main causes of German hyperinflation in the 1920s). By inflating the currency, the government imposes an implicit tax on citizens. Meanwhile, independence usually breeds credibility and credibility is key for the sustainability of the financial system. Credibility ensures trust and allows people to form reasonable expectations about inflation and future policy, without which investment and financial participation would plummet.
But an independent CBN would not be without fault. The failings of the European Central Bank (ECB) offer an insight. Widely considered to be the most independent central bank in the world, the ECB has been able to navigate the financial minefield of the EU crisis through decisive international action. However, it has also become emblematic of the friction between economic support and democracy as the ECB has often made assistance conditional on the adoption of policies disfavoured by the electorate.
The problem is that the choice between inflation and unemployment is as much a political choice as an economic one. It is a choice that concerns how we prioritise the interests and claims of different groups in society – between creditors and debtors, between citizens today and those of the future. To answer these difficult questions, we have devised the system of democracy and elected representatives to make these choices on our behalf. It is best if this choice is informed by economic theory but ultimately in a democratic state, such value judgment has to be made by elected officials.
Therein lies the power of this “democratic deficit” critique. One way out of it is by arguing that democratic considerations apply as much to the realm of monetary management as they do to managing an army, for example. But just like army chiefs, central bankers are technocrats who are tasked with determining the best potential technical solution. The buck stops with the civilian leaders when the final decision is made. This is not to say that central bank independence is wrong, but that it must be balanced with the democratic appeal for accountability and political deliberation.
Central bank independence remains highly proclaimed because it is believed to create a more effective central bank. But independence is just one of a range of variables that are necessary for this, and independence should be treated as an endogenous variable – the reason and degree of independence usually matters. The dubious past relationship between the federal government and the CBN is what makes it particularly important for the CBN to achieve goal independence. Or else, it will continue to be used to further political aims, noble or not. But accountability is clearly important too. An independent CBN that is accountable to no one is a dangerous aberration in Nigeria’s budding democracy.
*This relationship can be characterised by the Phillips curve and is the source of much debate in the discipline. You can read more about it here.
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