Central banks are amongst the most important players in financial markets worldwide. Central banks (reserve banks) are government authorities in charge of monetary policy. The actions of Central Banks affect interest rates, the amount of credit and the supply of money all which impacts not only financial markets but also the aggregate output and inflation. The essay that follows discusses the various roles of the Central Banks in the economy and further elaborates on why economists argue about their independence. ROLES, ACTIVITIES AND RESPONSIBILITIES IMPLEMENTING MONETARY POLICIES.
The most important goal of the Central Banks monetary policy is ‘price stability’ which basically means low and stable inflation. Other goals of monetary policy also includes. High employment which is important due to the fact that the alternate situation, ‘unemployment’ causes too much human misery. Economic growth is closely related to the high unemployment goal because businesses are more likely to invest in capital equipment to increase productivity and economic growth. When your employment is low it is harder to plan for the future (Mishkin, 2009).
Stability in the foreign exchange market is important as international trade is increasing and the value of domestic currency of a country relative to other foreign currencies has been the major considerations for the central bank (Jayaraman, 2014 (EC301 Study Guide)). Other further roles of Central Banks include: -Controlling the entire nation’s money supply. -Clearing checks. -Issuing New Currency. -Withdrawing damaged currency from circulation. -Regulating and supervising the banking industry. -Using their staff of professional economists to research topics related to conduct of monetary policy.
ECONOMISTS ARGUMENT ABOUT INDEPENDENCE OF CENTRAL BANKS There are two (2) types of independences of Central Banks. Firstly is the instrument independence, which is the ability of the Central Banks to set monetary policy instruments. Secondly is goal independence which is the capability of Central Banks to set goals of monetary policy (Mishkin, 2009). Due to Central Banks having both types of independence it is remarkably free of political pressures that influence other government agencies. A four year term is also put in place for the Board of Governors (thus they cannot be ousted from office), which is not renewable.
Furthermore, another even more important factor for Central Banks is its independent and substantial source of revenue from its holdings of securities and also independent from its loans to other banks. Central Banks return their earnings to the Treasury and thus does not get rich from its activities but this income however gives them an important advantage over other government agencies: as it is not being subjected to the appropriations process controlled by the government. The government accountability office, and the auditing office of the government cannot audit the monetary policy or foreign exchange of the Central Bank.
Because of the power to control the purse strings is usually synonymous with power of overall control and this feature of Central Banks contributes even more to its independence factor more than any other factor. Another argument factor towards Central Banks independence is that the control of monetary policy is to important to be left to politicians who in most economies have demonstrated a lack of expertise at making hard decisions on great economic issues such as reducing the budget deficit. (Mishkin, 2009)
. The strongest argument for independent Central Banks rests on the view that subjects the Central Banks to more political pressures would impart an inflationary bias to monetary policy. Advocates of independent Central Banks believe that a politically isolated Central Bank is more likely to be concerned with long-run objectives and thus be a defender of a sound dollar and stable price level. In conclusion, Central Banks are important financial institutions within economies hence delegating the power to implement far reaching policies to an independent institution requires guaranteeing its accountability. Only by making Central Banks accountable to the parliament would we be able to monitor the efficiency.