Central banks should have operational independence if they are to effectively implement a feasible monetary policy framework.
These were the remarks of Prof. Emmanuel Mutebile, the Governor Bank of Uganda during a two-day International Monetary Fund-BoU conference under theme “Transition to modern monetary policy frameworks in low income countries” held at the commonwealth resort in Munyonyo recently.
He explained that a Central bank must be allowed to set the policy interest rate to best achieve its monetary policy objectives without interference from other institutions or persons.
“A central bank which does not have operational independence would risk having its monetary policy influenced by other institutions or persons with objectives other than price stability, which would obviously weaken the central bank’s ability to control inflation,” he said.
Mutebile adds that statutory independence though necessary, is not a sufficient condition for the operational independence of the central bank.
“To be able to implement monetary policy in an independent manner, a central bank must also have sufficient instruments at its disposal, which it can use without having to seek the permission of other authorities.”
He notes that marketable instruments such as government securities should also be availed to the Central banks so that it can use them for monetary policy operations at its own discretion.
“One possible channel through which Government securities could be transferred to the central bank is through the capitalization of the central bank, as has occurred in Uganda,” he points out.
The IMF and Bank of Uganda organized workshop was convened to discuss the transition to modern monetary policy frameworks in low income economies in Africa. In essence, the discussion centered on the shift from a monetary targeting framework and, in a few cases, a fixed exchange rate framework, to an inflation targeting monetary policy framework.
Under the monetary targeting framework which the Inflation Targeting replaced, implementation involved primary issuances of government securities to align the quantity of reserve money, which was the operating target in the framework, with predetermined targets.
Explaining this, Dr. Louis Kasekende, the Deputy Governor Bank of Uganda said that the reason for the shift is mainly because the central bank needs to be able to influence closely, short term money market interest rates as the first step in the interest rate transmission mechanism.
“Secondary market operations give the central bank the flexibility to intervene every day in the money market if required and they also give the central bank the option of intervening with a fixed interest rate instead of a fixed quantity of money or securities.”
He added, “There is need to clearly differentiate monetary policy operations from fiscal policy operations. Under the monetary targeting framework, all primary issues of government securities were used to mop up liquidity in order to achieve a reserve money target, irrespective of the source of that liquidity.”
Prof. Mutebile however adds that for an inflation targeting central bank, it is imperative that government does not systematically borrow to finance the budget because this risks undermining monetary policy
This therefore implies that government has to be prepared to fully fund its domestic borrowing from the market and avoid borrowing from the Central Bank if Inflation Targeting is to be effective.
“Preferably there should be constraints on Government borrowing from the central bank set out in legislation. In Uganda we have such an agreement in principle.”
Source : East African Business Week