Effectiveness of the central bank depends on its autonomy

What you need to know:

  • For the BoT to fulfil its primary objective effectively, it is imperative that it maintains autonomy in devising monetary policy. Certainly, the BoT must be accountable to the Executive and Legislative branches of the government. However, at the same time, it must be allowed ample policy space to function independently.

The primary objective of the Bank of Tanzania (BoT) is “to formulate, define and implement monetary policy, directed to the economic objective of maintaining domestic price stability, conducive to a balanced and sustainable growth of the national economy of Tanzania.”

For the BoT to fulfil its primary objective effectively, it is imperative that it maintains autonomy in devising monetary policy. Certainly, the BoT must be accountable to the Executive and Legislative branches of the government. However, at the same time, it must be allowed ample policy space to function independently.

Since 2013, the Tanzania’s central bank has been able to keep the headline inflation rate at single digits. Clearly, this achievement had a lot to do with the good and transparent leadership of its Governor, Prof Benno Ndulu, a renowned macro economist. However, he and his colleagues were successful in curbing inflation because they had a good measure of freedom to implement monetary policies as they saw appropriate, considering the primary objective of the BoT.

While President John Magufuli has broken tradition in appointing Prof Florens Luoga (pictured), a non-economist, as the successor of Prof Ndulu, that in itself should not be a concern. Prof Luoga brings with him a wealth of broad knowledge that should enable him to be a successful governor. Moreover, he will be working with a team of very able economists, including Drs Yamungu Kayandabila and Bernard Kibesse, two of the deputy governors. There are also other macro economists at the BoT with very strong credentials, such as Drs Philip Balele, Wilfred Mbowe, and Suleman Misango.

What is important for any governor of a central bank is to keep his or her eyes focused on the primary objective of the bank and be able to work without debilitating political interference. Of course, being focused on domestic price stability is not to say that the BoT should be blindly single-minded. The economy, by its very nature, is a complex mechanism of many parts that are intertwined.

In countries such as Angola, South Sudan, and Venezuela, where inflation is currently very high, it is not because central bankers in those countries don’t understand macroeconomics and don’t know what to do to control prices.

It is mainly because central banks in those countries are more or less just appendages to the ministry of finance, serving the politics of the party in power and the dictates of the head of state. Through the ministry of finance, the government can order an irresponsible increase in the supply of money (printing of money) to finance budget deficits, and the leadership of the central bank has no power to refuse. The situation in those countries is reminiscent of the situation in the 1970s and 1980s in many African countries, including Tanzania.

Prof Luoga will assume the leadership of the BoT at a time when central banks in the East African Community (EAC) will be in the spotlight from within and without like at no other time before. Towards the end of 2013, the five leaders of the EAC met in Uganda and signed a protocol to establish an East African Monetary Union (Eamu) within ten years, that is, by 2023. (South Sudan, the sixth member of the EAC, was not yet a member.) Each central bank in the EAC will have its hands full steering monetary policy to meet certain macroeconomic convergence criteria.

While it is highly unlikely an Eamu will be established by 2023, the BoT will nonetheless be working with other central banks in the EAC to take steps towards a potential Eamu.

The pre-requisites for establishing the monetary union include full implementation of the protocols to establish a customs union and a common market, harmonisation and coordination of monetary and exchange rate policies, and the introduction of exchange rate bands. An exchange rate band is a combination of a floor and ceiling on an exchange rate.

For example, after agreeing on a base period, member countries could decide that the EAC currencies must not depreciate or appreciate by more than 5 per cent against each other. In addition, to join the Eamu a country must, for at least three consecutive years, meet certain macroeconomic convergence criteria.

One criterion is maintaining a ceiling of 8 per cent and 5 per cent on the headline inflation rate and core inflation rate, respectively. The headline inflation rate measures the rise in the general level of prices based on the prices of all goods and services.

The core inflation rate (also known as the underlying inflation rate) also measures the rise in prices, but it does not include food and energy prices.

If Tanzania truly commits itself to the establishment of the Eamu (hopefully, only through a referendum), the BoT must be given the autonomy to devise policies that will enable the country to meet convergence criteria on inflation and exchange rate.

However, with or without an Eamu in the horizon, the effectiveness of the BoT depends on its autonomy to implement policies that will achieve its primary goal of price stability.

Richard E. Mshomba is professor of Economics at La Salle University, Philadelphia, Pennsylvania, US.