Should the Central Bank of Jordan (CBJ) be independent of the government? This is an important question with significant implications that should be addressed by policy and its makers. Its answer must come from national experience and international best practice. Current economic research shows that the more independent the central bank the better it is for the economy.
The government is charged by law with funding government spending and has at its disposal taxes, fees, deficit finance and, potentially, money creation. Monetary policy in the past few years, given the peg of the exchange rate to the dollar, focused on curbing inflation and indeed it has been successful. Furthermore, the exchange rate has been maintained through reserves that exceeded 8.7 months of imports and a policy of watchful prudence that gained the trust of Jordanians at home and abroad.
While the budget deficit is expected to fall this year to somewhere close to 6 percent, due to a surge in new revenues (16 percent increase in revenues generated by the infamous VAT), economic growth remains an indomitable issue. Should growth be relegated to monetary policy? Economic theory conveys a clear message: a monetary policy that aims at increasing economic activity by increasing the money supply, will lead to short-term increases or bursts in output, but in the long run, the impact of such policy is only inflationary.
Hence, governments that straitjacket their central banks are leading their economies towards inflation in the long run, a view which was proved by Professor Alberto Alesina in 1989. Alesina looked at average inflation rates in seventeen industrialized nations over the period 1973-1986 and also at the degree of independence of their central banks. To determine the degree of independence, Alesina used information on institutional arrangements, including: whether government officials served on their boards; whether the government appoints the head of the central bank; whether there are formal arrangements for the central bank to finance part of any deficit with money creation; and so forth.
From this information he was able to construct an index ranging from 1 for the least independent (Italy, Spain, New Zealand, Australia) to 4 for the most independent (West Germany and Switzerland). The results of the study showed that countries with the most independent central banks had lower average inflation rates than countries with less independent central banks. The average inflation rate for Switzerland and Germany was 4 per cent, while the average for the four countries with the least independent central banks was 12 per cent.
Thus, evidence suggests that central banks which lacked independence have been used to print money by governments and create long-run inflation. Therefore, international evidence supports the argument to have independent central banks. Perhaps the most important lesson we have learned (or should have learned) from a decade of economic reform is the importance of focusing on what is necessary for Jordan to develop, not on what is urgent. Hence policy, all policy, should focus on long-term economic growth. The framework for the approach should be transparency, which we have also learnt is not a luxury but a necessary market element that reduces uncertainty and later headaches arising from speculation and conspiracy theories.
At the end of the day, real economic growth, conducted within a transparent framework, should be the bulwark of our approach and monetary policy, while being guided by the long-term interest of the nation, is to remain independent. — ( Jordan Times )
By Yusuf Mansur
© 2001 Mena Report (www.menareport.com)