The Reserve Bank of India Governor, D. Subbarao, on Friday said that the recent financial crisis had dented the credibility of central banks.
“The blame on central banks is wide ranging.......There is resentment, if not outrage, against the famed independence of central banks; and there is an outcry for clipping their mandates and tightening the accountability mechanisms,” said Dr. Subbrao while inaugurating the International Research Conference on ‘Challenges for central banks in the context of the crisis’, here.
The crisis saw unprecedented expansionary fiscal and monetary policies launched by governments and central banks in coordination. “As countries contemplate exit from these expansionary policies, the familiar tensions between monetary and fiscal policies are showing up again.”
There is widespread apprehension that many advanced country governments will not be able to wind down borrowing because of demographic factors and consequent growing social security payments. IMF studies estimate that even if the governments in the advanced economies reverse the crisis-induced fiscal stimulus, these economies will still end up with a structural primary deficit of 2 per cent of gross domestic product (GDP).
Government debt in the advanced economies is projected to jump from the pre-crisis level of 78 per cent of GDP in 2007 to 118 per cent by 2014 assuming some discretionary tightening beginning this year. In such a scenario, Dr. Subbarao said what were now seen as cyclical fiscal deficits might, in fact, morph into structural fiscal deficits. “We may then see the return of fiscal dominance and undermining of the independence of central banks.” While acknowledging that the responsibility for financial stability has to be shared by the government, the central bank and other regulators, Dr. Subbarao said that there were two related concerns: The first was that rescuing financial institutions was an inherently political act and getting involved in such decisions might compromise the technocratic credentials of central banks; The second concern was the risk that coordination with governments in the area of financial stability might spill over into other areas within central bank purview thereby undermining their independence.
All in all, “the case for central bank independence is coming under increasing assault as a result of crisis-led developments, said Dr. Subbarao adding that “The challenge for central banks is to make the case for independence not through weighty arguments but through more vigorous and voluntary efforts to be transparent, responsive and accountable.”