A new era of central banking

While many are interested to see what Bangladesh's central bank has been doing in recent years, some skeptics are asking: is what Bangladesh Bank doing part of a central bank's job? The history of central banking has changed sufficiently over time to outshine Darwin's theory of evolution. Once upon a time central banking played a compliant role to cater to the government's fiscal spending via monetary expansion. Gradually, it turned out to be a controller of the government's destiny, particularly in the developed world. The fact that the Fed chair is the second most powerful person in the US after the country's president is simply a wonder in most developing economies where finance ministers try to push the central bank governors to an irreducible corner.  Usually a central bank works through its monetary policy which has the dual mandate of employment maximisation and price stability. Central banking in developing economies, however, can have multiple objectives. The new era of central banking is an effective blend of both monetary and development economics in the countries that have been achieving over 5 percent growth in the last decade. Now there is no fixed definition of central banking. It is the most innovative financial art – crafted from a need based approach.

Most regimes are interested in making central banks provide demand side injections through printing money. A developmental central bank, however, has changed that limited image. Central banks should also be interested in the supply side investments that give the long run growth potential to a nation. Thus it is more important to give credit to a solar plant than a fashionable clothing store. Supporting technology and quality education gives a nation the long-term strength needed to make the growth momentum long lasting. The new style of central banking focuses on supply side capacity building as well as boosting demand side components, particularly private investment and consumption. 

Initially, a central bank was thought to serve as the piggy bank for the government. It is still true. Its main role as a regulator of all commercial banks has always been there. What is amazing is its developmental role which evolved dramatically with a colourful spectrum in least developed countries (LDCs). Central banking also added socially responsible duties in its portfolio. Central banks in many LDCs undertook a wide variety of projects on green initiatives, microfinance, women's empowerment, investment, entrepreneurship, infrastructure building, technology expansion, and sustainable energy. Is this multitasking? Are not these extra ventures diluting the typical definition of central banking? The answer is no. They are strengthening the supply side capacity of the economy to push its trend growth line higher than it is now. 

As long as the central bank is aptly exercising its stabilisation role as its core responsibility, there is nothing wrong in undertaking developmental activities. Rather, the developmental role acts like a multiplier when a central bank has a proven track record of stabilising inflation, interest rate, exchange rate, and GDP growth. For example, price stability and moderate inflation are preconditions for helping small and medium enterprises succeed. Financial stability is the precondition for successful financial inclusion. The accusation that central banks are taking up many responsibilities originally to be discharged by the government is simply an illusion of fear and a failure to understand the growing necessities of emerging economies. Now a central bank is a regulator with many attributes, just like a smartphone. A central bank is the powerhouse of capital that dominates almost everything in a bourgeois society. Many ministries despite having noble goals are thirstily waiting for funds. And a central bank can readily avail that amount in the most efficient way. Time has come for better cooperation between central banks and government ministries in developing economies. The sooner the realisation, the better the outcome. 

The Fed played the most crucial role as the saviour of the US economy by rescuing it from the Great Recession of 2008 and 2009. Time magazine named Ben Bernanke, the Fed chair, the Man of the Year in 2010. Friedman argued that the Fed could have played the most crucial role in the late 1920s in avoiding the Great Depression of the early 1930s. From Marx to Keynes, from Friedman to Piketty, all great economists underscored the ever growing power of capital. This has been more so in a rapidly integrating world where capital can move from one continent to another in a second. And a central bank is the main custodian of capital in an economy. A tactful engineering of capital by the central bank can change the fortune of a nation. Let us reassess the power of central banking from that angle. 

Time has come to change our mindset. Developmental central banking on top of inflation control is no longer a choice, it's a must. Financial penetration, which can be measured by the ratio between domestic credit and GDP, empowers the central bank with the most widespread network to operate in the economy. No single institution has that advantage. No ministries can reach that far to control finance and investment activities essential for growth. 

The success of the American economy in the 20th century heavily depended on the gradual autonomy of the central bank. In contrast, the governments that tried to impede central bank independence actually shot at their own feet. Latin America and Africa, where governments pushed their central banks aside, seriously suffered from hyperinflation and poor growth. Now the realisation is coming forth. For example, Argentina has given autonomy to its central bank of late. A new era of central banking has begun -- justifying an independent and innovative developmental role of central banks to make growth socially inclusive and fundamentally sustainable.

The writer is Chief Economist of Bangladesh Bank.