The importance of Central Bank Independence

Economic policymakers seek to achieve high employment, rapid growth and stable prices. I am most interested in the role of monetary policy – what it can contribute, and most importantly, how it should be conducted to contribute the most. It is a fact that there is strong correlation between central bank independence and effective output stabilization. At the heart of Zimbabwe’s economic meltdown is a central bank that has amassed a plethora of controls that go beyond its remit.

Substantial quasi-fiscal activities by the Reserve Bank of Zimbabwe (RBZ) have been at the core of the country’s headline-making hyperinflation. Such activities include subsidies made to loss making government-owned enterprises, price supports given to some export sectors, and the interest payments made on open market operations. These activities have eroded the bank’s ability to conduct monetary policy. The RBZ’s solution – printing more money, and freezing prices and wages – has been like pouring water on a drowning man. As a result, Zimbabwe’s central bank has achieved the opposite of what it was created for. Zimbabwe is going through what looks like a never-ending contraction characterized by high unemployment and negative growth.
To attract investment and rebuild the economy, a new monetary policy must be put in place. CATO analyst, Steve H. Hanke proposes replacing Zimbabwe’s central bank with free banking, a currency board, or official dollarization among other systems to restore confidence. I agree with Dr. Hanke that Zimbabwe needs to adopt a new monetary regime, but his proposals do not address the heart of the problem with Zimbabwe’s inflation, namely, the government’s interference with the nation’s monetary authority. As a long run strategy, there is no substitute to Hanke’s proposals, but in the short run, I suggest terminating the quasi-fiscal activities of the central bank, and moving all expenditures to the central budget office controlled by the Ministry of Finance.

Independent of the government, the central bank needs to set itself a steady course and keep to it. Experience has shown that independent central banks can make major contributions towards economic stability. Zimbabwe’s government needs to demonstrate commitment to greater fiscal responsibility. Unfortunately, the recent reappointment of central bank governor, Gideon Gono, tells of a leadership that is only interested in continuing its episodes of interventionist follies. They should also move to scrap price controls, which have only served to reduce availability and encouraged profiteering in the black market by persons (usually government officials) able to access goods at the set prices. Most importantly, there should be an urgent review of the central bank’s mandate with the goal of refocusing the central bank on monetary policy.