Analysis: Reserve Bank of Malawi’s independence is not a solution to its problems
We can learn best practices and methods and apply them to our contexts, after all that is the basis of education. We want to be able to do better with more knowledge, because societies, with limited knowledge, often lag behind those with superior knowledge in area that matter. This may sound simplistic, but it helps explain the differences in standards of living between many of the developing countries and developed countries. Developed countries have invested more in, and leveraged the knowledge economy to their advantage and are ahead of many other countries in wealth creation, health, education, banking, defence systems, general science and technology, and in some cases leadership among others. As knowledge is acquired, it is critical that it gets applied contextually, and more so in the critical sectors including central banking in developing countries.
The past few years have been disastrous for the world, Southern Africa and Malawi in particular. The Covid-19 pandemic took a devastating tool on man-power in Malawi, and its effects linger over time. That war depressed demand for exports, and analyses of commodity data showed that all commodities for which Malawi was a net exporter saw massive declines in prices, which precipitated into the nation losing the much needed foreign earnings as economic activities declines, and commodities sold for a song. As if this was not enough, the Russia-Ukraine conflict a seemingly remote event proved to be a negative shock on the economy as the reduced supply of fuels, fertilizers, and edible oils meant that prices thereof skyrocketed. This manly happened for those commodities for which Malawi is a net importer, as well as their substitutes imposing a huge import bill on distant economies including Malawi and thus draining the scarce foreign exchange that had already suffered a huge shock owing to the demand depressive effects of Covid-19 pandemic. A further shock of climatic nature, the El Nino induced drought have also yet imposed a further impact on the economy by depressing the agriculture sector and all those sectors for which agriculture has strong forward and backward linkages. All these crises have meant that the ability of the economy to stabilize has been undermined; not surprisingly, the currency has come under pressure, contributing to forces that have generated a depreciation.
Of course other central bank governance issues are important for the determination of the health of the currency. Some of these issues relate to creating environments that are attractive for businesses to keep their money in the formal banking sector. The fact that many businesses are unable to use the formal banking sector for safe keeping of their foreign exchange creates problems as such money doesn’t easily go into formal accounts within the Banking system. To try and solve this others have pointed to the important role of the Reserve Bank of Malawi (Central Bank) in bringing in sanity and trust into the banking sector. Others think that the Central Bank is too dependent on government and this is a problem whereas others are of the view that the Central Bank is too independent and such should reduce.
The usual argument in support of the Central Banks’s independence is that independence limits political influence in the conduct of monetary policy, and that therefore there is likely not to be time inconsistency problems in bank policy implementation. It is argued that an independent bank will be immune to political business cycles in which election years may be replete with expansionary policies to curb unemployment and lower interest rates, whereas in post-election periods, the negative effect of these policies may engender high inflation and interest rate. Such an argument, it is proffered, makes sense because politicians often present the usual principal-agent problem in which politicians as agent of the people (principals) they represent, often pursue their own goals rather than those of their principals and thus, they should be far located from central banking.
I put it that this argument is not as authoritative as it comes across unless the degrees of independence are clarified. Under certain assumptions, there are benefits to having a 100% independent central bank, but in practice, central banks are never really fully independent nor are they fully so dependent anywhere in the world. The Federal Reserve Bank, the European Central Bank, as well as the Central Bank of England, the Bank of China and that of Japan, have some level of dependence on, and independence from their governments and for a reason. The argument that a less independent central bank will pursue policies at the mercy of politicians is rather an exaggeration. The degree of independence or lack thereof for a central bank can be thought of in terms of its instrument independence i.e its ability to set monetary policy instruments as well as its goal independence- that is, its ability to set the goals of monetary policy.
A central bank for a nation exists to contribute to the nation’s economic prosperity by ensuring that it implements monetary policy responsibly and with regard to what happens on the fiscal side of an economy. It is therefore important that the conduct of such monetary policy does not occur in a vacuum. Furthermore, the central bank should be accountable to the public in some way for its conduct and such accountability mechanism can be effected in form of ensuring that its goals take account of the fiscal realities of the economy from time to time without of course turning it into a commercial bank with a huge risk of failure. Leaving a central bank to set both monetary policy instruments and goals of monetary policy alone and unaccountably can be economically dangerous especially in developing countries where principal-agent, adverse selection and moral hazard problems are numerous among workers owing to absence of strong institutions to counteract them. A too independent central bank would also mean that if the bank performs badly, no provisions may be in place to replace its key leaders, which is an oddity given that the bank is as important as the other key parts of government and efficiency is key. Moreover, the independence of central banks elsewhere has not always been used successfully, for example during the Great Depression as well as during the 1960s and 1970s in the USA, independence of the Central Bank did not cushion the USA of the banking related problems of that era. In any case, too much independence may lead to a Bank pursuing narrow self-interests rather than the public interest.
Even in Western countries and emerging economies, the practices are varied. For example, while the Federal Reserve system in the USA, and the European Central Bank have some considerable instrument and goal independence, the Bank of Canada does not control monetary policy following the Bank Act amendment of 1967 that gave the control of monetary policy to the treasury on paper. Although in practice the Bank controls monetary policy, the law therein exist to ensure the Bank does not turn to its own narrow interests. The goal for Canada’s monetary policy (inflation targeting), is set jointly by the Bank of Canada and the government. In England, until 1997, interest change decisions resided with both the Chancellor of the Exchequer (ie treasury) and the Bank of England because the conditions for such were conducive at the time, and even upon the change, the Bank was never given total instrument independence. The Bank of England has also been stripped of its supervisory and national debt management functions ie limiting its independence in some way. Again, just as in Canada, the Bank of England does not set inflation targets as this is the job of the government. In Japan, the government controls part of the Banks budget to limit its independence, whereas in China, the People’s Bank of China is required to report its decisions to the government even before implementation.
There is therefore a mix of evidence regarding central bank independence and effectiveness and it is clear that even among the bigger economies with strong institutions, lie central banks that do not enjoy complete independence from their governments. Independence appears to be helpful for the United States and the European Central Bank, but it is less embraced even in other Western economies because it would be too irresponsible to leave such an important part of an economy operate oblivious to the realities of many.
Thus, while this note does not imply that the Reserve Bank of Malawi should be made too dependent on the treasury and the public, it also does not support any attempts to make the Reserve Bank too independent that it becomes an entity unconcerned with the people and the economy it must serve. Striking a balance between the two extremes in a manner that takes into account Malawi’s own context is useful for a successful Reserve Bank of Malawi and hence reforms and legislation seeking to achieve this are called for. The effectiveness of the Reserve Bank of Malawi will depend on what it does within, how it executes its supervisory role of commercial banks, other finance institutions, and its interface with the realities of the economy, which at present depends primarily on agriculture, services, and industry.
Greenwell Matchaya, PhD (Economics)
Pretoria
Disclaimer: The views expressed in this note are those of the author, writing in his capacity as an expert in Economics and International Development and they do not represent any institutions (universities, international or local organizations) to which he is affiliated in one way or another.
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