ABSTRACT
The lack of an open and systematic analysis of central bank finances has long contrasted with the prominence achieved worldwide by the topic of central bank independence in the public policy arena. More specifically, the unanimous assessment that financial independence belongs to the set of crucial conditions for effective central bank independence lacked practicable models of central bank finances. This chapter aims to identify some of the elements of a conceptual framework to attain optimal central bank financial arrangements. This ambitious aspiration to an optimal solution may convey the impression that best practice as regards central bank finances can be summarized by some concise mathematical formula. Rather, best practice is understood here to be a basic consensus on the impact of a set of determinants (to be discussed later). Yet there are no ‘one-size-fits-all’ solutions. This chapter has benefited considerably from the rich exchange of experiences gathered in this volume. Ironically, a wrong question may lead on occasion to the right conclusions. The title of this chapter is an instance. The discussion of central bank finances from a funding perspective might suggest that liquidity can be as much a constraint in the central banking world as it is for a corporate. This can be true, for instance for currency boards needing to provide sizeable emergency liquidity assistance in foreign currency. However, ‘solvency concerns’ do not generally pose major material constraints for central bank policies. In fact the opposite is
so: the ability of central banks to create liquidity for free has given them some scope to deviate from mandated goals. Granted that solvency is not a primary concern for central banks, this chapter will focus on more immediate risks: distorted policy making due to the operation of biasing mechanisms where central banks’ financial affairs are decisive. Optimal financial arrangements constitute the appropriate institutional set-up to minimize the impact of policy biasing forces. Central bank financial affairs will encompass risks as well as income-related matters. It is the overall financial risk-return profile that shapes the potential for policy bias. This will direct our attention to rules allocating risk and return between central bank and government. Discussing best practice in the realm of central bank finances must involve some taxonomy. The diversity of arrangements leaves little opportunity for deriving concrete and universally valid rules aimed at strengthening central bank finances. However, one can still distil important general principles, whose summary is listed below:
1 Central bank independence is fostered when the asymmetric position of central banks vis-à-vis governments is neutralized, not just in policy but also in financial affairs. Central bank financial independence is the institutional framework that enables this goal.
