Central banking: some "secrets of success"
Speech by Malcolm Knight, General Manager of the BIS, at the Bank of Albania Open Forum on 'Preconditions for launching inflation targeting in Albania', Tirana, 1-2 December 2005.
There are three key elements to the consensus that has emerged about successful central banking: first, a clear mandate and objectives; second, sufficient autonomy to perform mandated functions; and third, accountability for policy actions and the stewardship of resources. The clear objective and substantial autonomy given to the Bank of Albania in the 1997 law provide a good foundation for its operations. Continued clarity of message, further refinements in the monetary policy process and constant attention to the sound management of the central bank are essential for retaining public trust and permitting the central bank to achieve its policy objectives.
Institution-building is a gradual and complex process, especially in the field of central banking. A key ingredient is to think ahead, and I congratulate the Bank of Albania on doing so by organising a meeting like this one. It is a pleasure to be here.
My talk on the “secrets of success” for a central bank will be brief - and not only because this is a dinner speech. More importantly, many of the purported “secrets” of a successful central bank are already well known here at the Bank of Albania. The Bank has statutory independence and is widely respected, and this goes a long way to explain its success in keeping inflation in a 2 to 4% target range. This will be the first point of my remarks.
In the second part of my talk I will discuss some concrete aspects of inflation targeting. Third, I will say a few words about the appropriate institutional arrangements for monetary policy decision-making. Finally, I will argue that even very successful central banks need to remain vigilant and work to ensure continued success. Because the Bank of Albania is highly respected, it is important for it to remain focused on core tasks, to manage reputational risks, and to continuously demonstrate its good stewardship of resources.
Some “secrets of success”
Over the past few decades, a consensus has emerged about what makes for good central banking. This has permitted central banks to deliver a very important public good ─ price stability ─ and has afforded them the opportunity to contribute to greater financial stability. One way of summarising this consensus is in terms of three key elements that make the central bank effective as a policy institution.
The first element is for the central bank to have a clear mandate. As Yogi Berra - the legendary American baseball player and manager of the New York Yankees - once said, “If you don’t know where you’re going, you will wind up somewhere else”. Central banks know where they are going. New central bank legislation generally accords primacy to price stability as an objective. Where statutory changes have not been made, existing legislation has been interpreted in such a way that achieving price stability is seen as the sine qua non for attaining mandated objectives. More generally, the public has come to expect central banks to deliver price stability.
The second key element is autonomy. If central banks are to achieve the objectives that have been set for them, they need to have sufficient autonomy to do so. Without it, there is a risk that short-term political or fiscal considerations will dominate. Therefore, central bank policy decisions need to be shielded from undue political pressure or sectarian interests.
Accountability is the third key element of effective central banks. It is closely linked with the other two. If a central bank is given autonomy to achieve a certain objective, it needs to be held to account for its success or failure; and the clearer the objectives, the easier it will be to determine success or failure.
How does the Bank of Albania score in these three areas? De jure, very well indeed. In many ways, the Bank of Albania Law, which was passed in 1997 - the year the pyramid schemes collapsed - is an example of very modern central bank legislation. The first three articles of the Law cover the three key principles that I have just mentioned. Article 3 stipulates a clear objective “to achieve and maintain price stability”. Article 1 provides that the Bank shall be “entirely independent from any other authority in the pursuit of its objectives and the performance of its tasks”. And Article 2 specifies that the Bank “is accountable to the People’s Assembly of the Republic of Albania”. These are essential attributes for a successful modern central bank. Nevertheless, there always is scope for further enhancements, as is recognised by holding this Forum. Abolishing the possibility of direct central bank financing of any government deficit is key in that connection, since experience across many countries has amply demonstrated that fiscal dominance can quickly undermine any stability-oriented monetary strategy.
Turning from model statutory provisions to practice is never easy. A number of countries have only begun to do so, and even in long-standing open societies there is no guarantee that the autonomy of the central bank will always be respected. Against this backdrop, I find it particularly impressive that the autonomy of the central bank appears to be well and widely accepted in Albania. This has no doubt helped the Bank of Albania to deliver price stability.
Aspects of inflation targeting
As you know, there are many forms of inflation targeting, and there is no sharp behavioural distinction between central banks that have formally adopted inflation targeting and those that do not use this term to describe their actions. Even those that use the label follow significantly different practices. You can argue that two of the Bank of Albania’s current practices - the use of a numeric inflation objective and the regular publication of a report on monetary policy – are important ingredients of any inflation targeting approach.
However, inflation targeting is of course more than that. All inflation targeting central banks publish conditional forecasts of inflation. These forecasts serve the dual purpose of being a key element in monetary policy decisions and a communication tool. Taking this step when you are in the initial stages of modelling your inflation process and understanding the transmission mechanism of monetary policy is no small task.
That brings me to the internal aspects of an inflation targeting framework - aspects that are of key importance. These are the activities and procedures that take place behind the scenes of a central bank to implement a monetary policy that will achieve its stated objective. As the central bank enhances its technical work and expertise in monetary analysis and operations, there is often heightened demand for econometric research, analysis of current economic developments, and systematic forecasting procedures. If monetary policy decisions are made by a committee, there is increased demand for staff to support the work of all the members of the committee. And there is a greater need for professional staff to formulate the regular, systematic communications that are part and parcel of an inflation targeting framework. The past successes of the Bank of Albania and the ambition and motivation behind this meeting are to me strong indications that it will continue to make a big effort to meet this challenge.
Several factors are commonly mentioned in favour of collegial decision-making in a central bank. More information and a wider range of views are brought to the table. Decisions are better grounded in the community. And there is less risk of clandestine influence by the government.
Collegiality can be achieved in a committee with a single function, such as the Monetary Policy Committee of the Bank of England. Or it can be achieved by relying on a board that performs several functions, as in Australia and Sweden. However, on the whole, it is increasingly common to have a separate monetary policy committee, or for the principal board of the central bank to meet separately to discuss monetary policy issues (the Governing Council of the ECB is an example).
If a decision is made to move in the direction of collegiality in policymaking, there are of course several ways to get there. One is to change the law, as happened in the United Kingdom. Another is to adopt practices that are consistent with the law - the Monetary Policy Committee at the Bank of Thailand and the Governing Council at the Bank of Canada are cases in point. The choice in this area will depend on the political landscape of the country concerned and on the willingness to accept the risk of opening a Pandora’s box.
Meeting future challenges
The media, markets and politicians place powerful demands on a modern central bank. This is particularly true in a small country where the central bank is one of the most professional and highly reputed institutions. However, there are some demands that can deflect the central bank from achieving its basic objectives. A young central bank in a small country needs to think hard which of these demands it should seek to meet. For example, central banks are often urged to do as the Bank of England and the US Federal Reserve do and publish minutes and voting records of monetary policy meetings, as well as to publish the full spectrum of reports, including an annual report, a regular monetary policy report, a financial stability review, a research bulletin and a monthly statistical report. Yet the release of information that attributes specific positions to named individuals risks exposing the policymaking process to political pressure. And the production of massive amounts of information is costly and risks obscuring key messages. In some cases less is more. The options need to be weighed carefully.
A key imperative for a successful central bank is to continuously demonstrate its impartial professionalism. It needs to show that it keeps its own house in order. Internal controls and audit, an effective procurement system, contingency planning, information management, risk mitigation and a range of similar subjects need to be on the Governor’s and the Board’s agenda in the same way as attention to new advances in the art of monetary policymaking.
Let me conclude by distilling what I take to be the true “secret of success” for a central bank. It can be put very simply. The true secret is that there are no secrets. Transparency and clarity of message and mission are the hallmarks of successful central banks the world over. To be successful, central banks need to be open and transparent.
By contrast, the secret of success for me as a speaker this evening is to come to a close and to be that elusive one-handed economist, who simply raises his glass to toast the success of this Bank of Albania Open Forum.