The declaration of dependence

Is the National Bank of Kazakhstan independent of politicians?


Should politicians control the central bank, which manages the nation’s money supply?

Proponents of a political bank argue that it would enable the government to coordinate monetary policy (how much money should we print?) with fiscal policy (how high should taxes be?). An apolitical bank might work at cross-purposes with the legislature. Suppose that the solons try to resuscitate a sluggish economy by taxing less and spending more. The central bank could squash this attempt by raising interest rates, discouraging firms and households from borrowing money to spend. William Greider, a journalist who wrote a searing -- if populist -- history of the American central bank, Secrets of the temple, argued that the Federal Reserve should seek the approval of a Congressional oversight committee before doing anything serious.

Most economists oppose a political central bank. They reason that voters vote their pocketbooks. A political bank may inflate the money supply in order to juice up spending, creating jobs and wealth for just long enough to re-elect incumbents. Prices will rise later, destroying purchasing power and leading to layoffs, but who cares? That’s a headache for future politicians.

There is a little evidence of such a political business cycle. United States Democrats accused Arthur Burns of inflating the money supply before the Presidential re-election bid of his friend Richard Nixon in 1972. In South Korea, the government loosened regulations on household loans in time for the presidential election of December 2002. Consumption boomed. After the election, the government clamped down again on household borrowing. Consumption swooned, and Korea entered into its second recession ever, wrote Jahyeong Koo.

Harry’s woodshed

One problem with policy coordination is that it may outlive its purpose. The Federal Reserve had kowtowed to the U.S. Treasury during and after World War II, when it agreed to buy federal bonds in order to keep interest rates below 2½ percent, noted Marvin Goodfriend. (Purchases of bonds raise their price and thus lower their rate of return to the buyers. This yield is essentially the interest rate.) In effect, the Fed had agreed to pay the federal debt by printing dollars, which it exchanged for the Treasury’s bonds. Thus the Fed surrendered to the Treasury the management of the money supply. The Fed had intended to cut the government’s cost in fighting the war, but its understanding with the Treasury continued for years after peace had broken out.

In 1951, the bank declared its political independence when it said it would no longer create money to pay Uncle Sam’s debt. Alarmed, President Harry Truman tried to strong-arm the Fed into financing the ongoing Korean War. He summoned to the White House the Fed panel that oversaw the bank’s bond trades. Truman told members of the Open Market Committee that they had to cut the government’s borrowing costs since it might face a world war. Boosting interest rates instead would help “Mr. Stalin.” After this woodshed rendezvous, Truman announced that the Fed had agreed to pay the debt. The Fed quickly set him straight. Truman reluctantly gave in, because he was in an imbroglio over firing General Douglas MacArthur for seeking to invade China, wrote Robert Hetzel and Ralph Leach.

In creating the Fed in 1913, Congress made it independent in order to keep politics out of the regulation of commercial banks. Each Fed governor serves one term of 14 years (unless she is filling in for an unexpired term). The Fed need not worry that Congress will cut its budget, because it pays its own way. It earns interest on government securities, returning its considerable profits to the Treasury.

Don’t RSVP, please

Not all presidents twist bankers’ arms. In the early years of the Federal Reserve, Woodrow Wilson wouldn’t invite its governors to his White House get-togethers, for fear of influencing them, noted Fed historian Allan Meltzer in an interview.

Some guarantors of bank independence have been more subtle than Wilson. The European Central Bank exists by treaty with the nations of the European Union. They must unanimously agree to any change in the treaty -– a difficult provision that helps ensure the bank’s independence, noted Nobel laureate Finn Kydland and Mark Wynne. In the early Nineties, before the European Central Bank had set up shop, the central banks of Spain, Portugal and Greece were obliged to buy some fraction of the governments’ bonds, thus risking inflation, wrote Joydeep Bhattacharya and Joseph Haslag. Judging from the news of the past year, old proclivities die hard.

Since World War II, it has been evident that countries with political central banks tend toward much higher rates of inflation -– with no gain in output -- than countries with independent banks. In 1956, when the ornery Bundesbank raised its discount rate by one percentage point, Chancellor Konrad Adenauer chastised it: “The guillotine falls on the man in the street.” But the German Miracle followed, noted Hetzel.

In the early 1990s, Kazakhstan’s annual rate of inflation soared above 2,100 percent. Later, when the National Bank of Kazakhstan became independent, it brought down inflation to single digits within seven years, asserted the Bank.

Nevertheless, the government here is conspicuously authoritarian, and questions about the Bank’s independence linger. In her MBA thesis at KIMEP early this year, Ainur Rakhisheva looked at how changes in the inflation rate might have affected changes in the tenge supply from 2000 to 2011. Presumably, if the National Bank is politically independent, then it will tend to respond to accelerating inflation by increasingly tightening the money supply in order to bring prices back down. Looking at monthly data and three-month averages, Ms. Rakhisheva did not find a systematic relationship.

Clearly, this research is a beginning. The Bank may respond to inflation data after a lag of more than three months. Its decision of whether to tighten money may depend partly on whether the economy is already operating at full capacity, forcing it to respond to new money only with higher prices, not higher output. Nevertheless, given the evidence at hand, perhaps one may give the claim of Bank independence the Scots’ verdict: “Not proven.” -– Leon Taylor, tayloralmaty@gmail.com

Disclosure: I reviewed the thesis along with Dr. Mujibul Haque, a KIMEP finance professor. The adviser was Dr. Dana Stevens, also a KIMEP finance professor.

Good reading


Joydeep Bhattacharya and Joseph H. Haslag. Reliance, composition, and inflation. Federal Reserve Bank of Dallas: Economic and Financial Review, pages 20-7. Fourth quarter, 2000.

Douglas Clement. Interview with Allan H. Meltzer interview. The Federal Reserve Bank of Minneapolis: The Region. September 2003.

Marvin Goodfriend. The phases of U.S. monetary policy: 1987-2001. Federal Reserve Bank of Richmond: Economic Quarterly, pages 1-17. Fall 2002. Online.

Robert L. Hetzel. German monetary history in the second half of the twentieth century: From the Deutsche mark to the euro. Federal Reserve Bank of Richmond: Economic Quarterly, pages 29-64. Spring 2002.

Robert L. Hetzel and Ralph F. Leach. The Treasury-Fed Accord: A new narrative account. Federal Reserve Bank of Richmond: Economic Quarterly, pages 33-55. Winter 2001. Online.

Jahyeong Koo. Nature of recent economic distress in South Korea. Federal Reserve Bank of Dallas: Expand Your Insight. April 16, 2003. Online.

Finn E. Kydland and Mark A. Wynne. Alternative monetary constitutions and the quest for price stability. Federal Reserve Bank of Dallas: Economic and Financial Policy Review 1:1, pages 12-13. 2002. Online.

Allan H. Meltzer. A history of the Federal Reserve. Volume 1: 1913-1951. The University of Chicago Press. 2003. Definitive.

References


Federal Reserve Bank of San Francisco. U.S. monetary policy: An introduction. 2004. Online.

National Bank of Kazakhstan. Overview of the monetary policy of the National Bank of Kazakhstan. October 2004. Online.

Ainur Rakhisheva. Independence and central bank efficiency in a case study of Kazakhstan. KIMEP: MBA thesis. Spring 2011.