Central banks vs political crossfire

The heightened role of central banks, which are also known as reserve banks, has, in recent times, taken centre stage in domestic and international policy circles. Three key reasons inform this proposition. One, maintaining the integrity and stability of the global financial order invokes the obligation for cooperation amongst reserve banks, the World Bank, the International Monetary Fund, development finance institutions et al. Two, reserve banks are at the heart of monetary policy. They play a crucial role in setting interest rates which, in turn, impact commercial and personal lending rates, as it does mortgage quotients; they shape money supply whilst framing policies on cash reserve ratios. Three, they are lenders of last resort to their governments.

Seminal questions have been raised as to the proper role of Central Banks across various jurisdictions. Should they, for example, be part and parcel of the executive arm of government? The logical foundation here is premised on the fact that a genuine democratic government is elected into office upon the strength of its manifesto pledges, the leadership qualities of its key dramatis personae and the extent to which it can enduringly inspire the confidence of the majority of the voting public. That being so, the argument here is that it is entirely reasonable for a Reserve Bank to be under the leadership of the relevant cabinet minister, for example, the Chancellor of the Exchequer or Finance Minister. The allure of this model is, it is claimed, sharper strategic coordination, clear ownership and effective policy execution.

Plus, the buck stops with the said minister for good or ill. And that was certainly the position in the UK, where the Chancellor was in charge of the government’s fiscal and monetary policy. A germane historical allusion was the 1992 Sterling crisis, which prompted the UK Sterling’s exit from the European Exchange Rate Mechanism; pursuant to the country’s inability to retain its exchange rate above the baseline requirement for the ERM participation. The policy choices were pretty stark; do nothing and watch inflation, averaging 6.35%, in the three years to 1992, skyrocket; or, shore up the pound, avoid devaluation and stay in the ERM. The government sort to shore up an underperforming sterling and thus remain in the ERM, by expending billions of foreign exchange reserves to purchase the pound. The latter didn’t work and ended up costing the economy over £3.2 billion. Then Chancellor, Norman Lamont (since elevated to the House of Lords), fell on his sword following this debacle!

That episode prompts the poser on whether monetary policy ought to be independent of the executive arm of government? Pro-independence advocates posit a simple but compelling countervailing argument. That is, monetary policy should not be exclusively determined by politicians, in ministerial garbs, because of conflicting interests. The inherent conflict is that their political calculations and ideological positions may well supplant the overriding national interests of economic growth, price stability, low inflation and genuinely manageable national debt burdens – which are relative constants in prudent economic management policies.

Therefore, it is argued, that monetary policy should always be determined by independent reserve banks under the steer of economists, policy experts, business leaders with, as necessary, input from consumers or other key stakeholders as local circumstances demand. The attraction here is the ostensible detachment from political pressures. This is the position in the United States, with the Federal Reserve Bank, a quasi-independent government agency, established under the Federal Reserve Bank Act of 1913. It is semi-independent because its members are appointed by the US President. However, Congress sets its monetary policy objectives: maximum employment, price stability and effective financial stewardship. Crucially, elected officials are not permitted to serve on the board of the Reserve.

The UK’s reserve bank, the Bank of England, founded in 1694, was granted quasi-independence in 1998, with a remit to support the economic priorities of the elected government and full independence in maintaining price stability. The latter function is exercised by a Monetary Policy Committee of nine members of which four are appointed by the Chancellor. Members are appointed on the basis of economic and monetary policy expertise. Just like the US and UK models, Nigeria’s reserve bank, the Central Bank, is partially operationally independent of the executive arm of government and monetary strategy is steered by a monetary policy committee “MPC” comprising 12 members chaired by the Governor. The overarching functions of the MPC are to: review economic and financial conditions in the economy; determine the appropriate policy direction over the short to medium term; adaptably review the Bank’s monetary policy framework; and effectively articulate monetary/financial policy decisions to the public.

A rather contentious characterisation of reserve banks relates to their exercise of the lender of last resort role. What does this mean in practice? Is it necessarily completely divorced from the political objectives of an elected government and its emanating cross-fire? Does it give a government carte blanche over failed economic policies? Who determines the quantum of the lending capacity of the lender of last resort? How can future generations be insulated against economic mismanagement under the cover of lender of last resort? In the main, are there effective and robust checks and balances in the purposive execution of this important function?

Proceeding from first principles, a lender of last resort, in its simplest form, simply means one who lends when all other economic remedies and therapies have failed. In short, there is nowhere else to turn, but to a reserve bank. The inference therefore is that reserve banks are de facto “national insurance entities,” as contradistinguished from de jure entities like national deposit insurance organisations. As such, Central Banks come to the rescue of their national governments in extremis. For instance, if there’s an enduring and significant loss of consumer confidence prompting a run on the banks; a rapid and sustained depletion in the value of gilts or sovereign bonds; draconian economic policies which seriously harm investment, legitimate capital repatriation and competitive international free trade; or, indeed, a global pandemic like COVID-19, which upends the most well-intentioned economic strategies.

Deployed imaginatively, the lender of last resort function is a virtuous function of reserve banks. A pertinent example of this is Quantitative Easing (QE). The fundamental point of QE interventions was, and is, to maintain the integrity of the financial order, safeguard consumer confidence and re-activate economic activities. The mechanism aims to boost money supply into banks and reduce interest rates. In turn, banks can on-lend to businesses and consumers on competitive terms, which can better facilitate business expansion and home ownership via credible mortgages.

To put this into some context, since the US Federal Reserve (the “Fed”) began deploying QE as a policy instrument, its balance sheet has ballooned. The first three QE deployments witnessed an increase in the Fed’s assets (bonds, securities, treasury bills etc.), from circa $882 billion in 2007 to approximately $4.473 trillion in 2017. More recent QE rounds have increased the Fed’s assets to over $8.5 trillion. Likewise, between 2009 and 2020, at the height of the economic and sub-prime mortgage crisis, which witnessed the sinking of Lehman Brothers, Northern Rock, American Home Mortgage Corp etc; the Eurozone debt crisis, interspersed with the aftershocks of the 2016 Brexit referendum; plus, the COVI-19 pandemic/furlough schemes; the Bank of England’s QE interventions rose from £200 billion to over £1.9 trillion.

In Nigeria, QE is practically undertaken through the controversial “ways and means” programme administered by the Central Bank. The term “controversial” is used advisedly because it has been the subject of feisty debates in various quarters in the country and amongst legislators. The “ways and means” advances are off-balance facilities by the reserve bank to fund federal government expenditure. Opinion is sharply divided as to the strategic propriety of this “QE” mechanism. The Central Bank contends that it is acting within its remit as a lender of last resort to the federal government and cites section 38 of the Central Bank Act 2007 viz “the apex bank may grant temporary advances to the Federal Government with regard to temporary deficiency of budget revenue at such rate of interest as the bank may determine”. Yet, critics including the World Bank and Fitch Global rating agency, contend that such off-balance sheet financing imposes unsustainable fiscal constraints upon the country’s expenditure. They argue that as of December 2021, the Federal Government had borrowed N17.46 trillion from the Central bank, which, by October 2022, had risen to N23.77 trillion, an increase of 36.13%. How sustainable is that?

Still on money supply, the quasi-independent Central Bank, launched new currency designs in October 2022 and signalled the expiration of the old notes by January 31, 2023. The policy intentions behind this change were, and are, sound; to curb terrorist financing, control illicit money supply, encourage people to adopt trackable electronic payments away from cash-based transactions and, of course, tackle corruption. The legal foundation therein was established in section 20 (3) of the Central Bank Act supra. The latter enables the bank, at the president’s direction, and upon giving reasonable notice, to call in old currency and coins, which shall cease to be legal tender, albeit, subject to section 22 therein, which shall be redeemable by the bank. The implementation of this change has been fraught with various complexities nationwide prompting long queues at cash point machines. The deadline has since been extended to manage and resolve the implementation challenges.

On the other hand, the bank’s quasi independence, is inseparable from the politically stated aims of the present administration; curbing corruption, tackling terrorism/insecurity and catalysing economic growth. In that sense, one reasonably infer a degree of convergence between the political objectives of the current administration of President Buhari, and the quasi-independence of the Central Bank.

Notwithstanding the operational independence of reserve banks, they cannot act in isolation of their political and socio-economic milieu. There will always have to be a degree, whatever the level of granularity, of ideological consonance with the policies of the elected government. What, after all, would be the point say, of an independent reserve bank, that’s undermining the low inflation targets or anti-corruption drive of the relevant national government?

Closing, whilst there are no certainties in life, much less in financial stewardship, nevertheless, important mitigating strategies against political pressures abound. My recommendations are that these should reasonably include ensuring the right leadership and the mix of experts and consumers, representing the interests of ordinary people in monetary policy committees. It also implicates the genuine independence of reserve banks on monetary policy, which does not inexorably imply working at cross-purposes with elected governments; ensuring that reserve banks’ policies do not unwittingly inflict hardship on people through well-intentioned policies bedevilled by sub-optimal implementation and significant major technological and connectivity deficiencies; robust oversight by parliament is essential to ensure reserve banks act within their statutory remit. Of course, reserve banks owe the public and succeeding generations a duty of care to consistently maintain economic prudence and stability with minimal political interference.

Ojumu is the Principal Partner at Balliol Myers LP, a firm of legal consultants, in Lagos, Nigeria.