The Political Economy of Central Banking in Emerging Economies

Mustafa Yağcı

• Publisher: Routledge
• Year: 2020
• ISBN:
  9781000164770
• Edition: 1
• Topic: Economics
• Subtopic: Banks & Banking
• Index: Economics

Since the start of the Global Financial Crisis in 2008, research on central banking has gained momentum due to unusual levels of central bank activism and unconventional monetary policy measures in many countries. While these policies drew significant attention to advanced economy central banks, there has been much less academic focus on central banking in emerging economies. This book extends the research on the political economy of central banking by focusing on the emerging economies in Asia, Africa, Latin America, and the European periphery. Central banks are at the heart of economic policymaking, and their decisions have a significant impact on the social and economic well-being of citizens. Adopting an interdisciplinary political economy perspective, the contributions in this book explore the reciprocal relations between politics, economics, and central banks, and how the global and domestic political economy contexts influence central bank practices. The chapters employ diverse theoretical perspectives such as institutional and organizational theory, developmental state resource dependency, and gender studies, drawing on disciplines ranging from politics, international relations, public policy, management, finance, and sociology. This book will appeal to academics and students of central banking, political economy, and emerging economies, as well as professionals and policymakers engaged with central banks, monetary policy, and economic development.

1 Introduction

Political economy of central banking in emerging economies

Mustafa Yağcı

After the onset of the global financial crisis, central banks have taken over the policy debates with their unprecedented and unconventional measures. ‘Quantitative easing’ (QE), which refers to policies that expand the monetary base with asset purchases and lending programs, became a buzzword (Fawley & Neely 2013) in central banking jargon. With these measures, the central banks in advanced industrialized countries aimed to lessen the negative impact stemming from the global financial crisis and to stimulate economic growth in crisis affected advanced countries. The then Managing Director of the International Monetary Fund (IMF), and currently the President of the European Central Bank, Christina Lagarde hailed the central banks in advanced economies as ‘heroes’ because, with their unconventional policies, the world economy avoided another Great Depression (Lagarde 2013). The transformation in central banking activities and the dominance of monetary policy in economic policymaking started the debates that central banking became the ‘only game in town’ in advanced industrialized countries (El-Erian 2016). It is with this background that we witness populist backlash to central bank policies in both advanced and emerging economies (Canepa & Koranyi 2018).

Notwithstanding the critical role major central banks played in the aftermath of the global financial crisis, to have a global comprehension of central banking in the world, we need to understand the conditions under which central banks in emerging economies operate, why and how they take specific policy decisions, and how their policies create social, political, and economic repercussions. Accordingly, this volume aims to bring the emerging economy central banks back to the debates on central banking and monetary policy so that we can have a global understanding of the central banking phenomenon. In doing so, we hope to enrich our theoretical, empirical, and methodological understanding of central banking. Some of the questions we aim to answer in this volume include, but are not limited to, under what conditions emerging economy central banks take specific policy actions, how the political economy context influences their operations and vice versa, how global dynamics influence them and whether they have an influence on other policy domains.

We tackle these and other questions with an interdisciplinary perspective to highlight that we need a multidimensional perspective to understand central banking behavior and its reciprocal relationship with economic well-being, political struggles, and overall social welfare. With our political economy emphasis, we not only examine the interactions between politics and economics but also identify the winners and losers from central bank policies. Furthermore, in our volume, we aim to emphasize the political economy context within which central banks operate. Central banks do not operate in a vacuum, and we need to contextualize their activities within relevant constraints and enablers. Without a clear understanding of international and domestic political economy forces at play and the resulting historical specificities, we cannot make sense of why and how central banks take specific policy decisions and how their activities influence social, political, and economic dynamics. In this respect, the characteristics of political regimes, the structure of the financial system, the organization of bureaucracy, the macroeconomic framework with critical components of the exchange rate and capital account regimes, external relations with other states and international organizations, state-business relations, and the nature of the economic growth model adopted in different historical periods constitute some of the critical political economy dynamics that can be studied in our contextualization efforts.

This introductory chapter sets the stage for our volume and gives a short comparative historical background on central banking in emerging economies. The next section briefly analyzes the history of central banking with major shifts in the central banking paradigm. The second section examines the earlier literature on the political economy of central banking in emerging economies, and the third section delves into the central bank independence debate with comparative analysis of central banks in different regions of the world. The fourth and the last section provides a synopsis of the chapters in this volume.

A brief history of central banking

The foundation of early central banks took place for different reasons. The earliest of central banks such as the central bank of Sweden (Sveriges Riksbank was founded in 1668), the United Kingdom (Bank of England was founded in 1694), and Spain (Banco de Espana was founded in 1782) were founded mainly to finance wars (Schenk & Straumann 2016, p. 325). Early central banks in France, Finland, the Netherlands, Austria, Denmark, Portugal, Germany, Italy, Japan, and the United States were founded for economic or political reasons. Economic reasons included managing public debt, promoting economic growth, ensuring macroeconomic stability, regulating the financial system, and acting as the lender of last resort. Some of the political reasons for the establishment of central banks were ensuring monetary sovereignty, consolidating note-issuing authorities to become a single note-issuing entity, and modernizing the political and economic system (Schenk & Straumann 2016, p. 325).

During the early 20th century, international organizations such as the League of Nations and established central banks such as the Bank of England and Federal Reserve (Fed) were instrumental in the foundation of other central banks. For instance, the League of Nations was instrumental in the establishment of central banks in Austria, Poland, Hungary, Czechoslovakia, Estonia, Bulgaria, Greece; Bank of England advisers played critical roles in founding the central banks of South Africa, Australia, New Zealand, Brazil, Canada, India, El Salvador, Argentina, and Egypt; and Fed officials played an advisory role in the establishment of central banks in Colombia, Chile, Ecuador, Bolivia, and Peru (Schenk & Straumann 2016, pp. 332–334).

One of the essential critical junctures for the trajectory of the central banking paradigms is the Great Depression experience. The Real Bills doctrine was the most prominent central banking doctrine during the Great Depression era. According to this doctrine, the ultimate objective of monetary policy should be to provide sufficient credit for trade. Resultingly, during economic expansion periods money stock and credit increased, whereas during recessions they declined (Meltzer 1976, p. 455). Friedman and Schwartz ([1963], 2008) asserted that the overreliance on the Real Bills doctrine during the Great Depression turned a financial crisis into a depression because the Fed let the stock of money in the economy to decline and did not provide the desperately needed liquidity to the financial markets. This novel explanation of the Great Depression was influential in the rise of the ‘monetarist’ central banking paradigm and led to the adoption of unconventional measures in the aftermath of the global financial crisis (Bernanke 2002).

The world economy experienced a surge of inflation rates starting from the 1960s. There was a pursuit of finding remedies to the high inflation rates, and Milton Friedman proposed a simple remedy to solving the inflation problem with his famous quote ‘inflation is always and everywhere a monetary phenomenon’ (Friedman 1970, p. 11). In other words, only monetary policy could tackle the surging inflation rates, and central banks should be the primary organizations for conducting monetary policy. This simple prescription and the diffusion of other neoliberal ideas since the 1970s led to the emergence of the monetarist central banking paradigm. Friedman (1982, p. 100) himself acknowledges that the broad consensus on the monetary policy strategy emerged as a result of experiences rather than theoretical developments. Thus, the dictum of the monetarist paradigm that ‘the long-run objective of monetary policy must be price stability’ started to significantly influence central banking practices around the world (Friedman 1982, p. 100).

The rise of the monetarist paradigm and the decisive role central banks play in the conduct of monetary policy paved the way for the adoption of central banking independence around the world. Nevertheless, Friedman advocated a constant money growth principle in monetary policy, in contrast to central bank independence (Friedman 1962; Nelson 2008). Consequently, central bank independence has become a global norm in conducting monetary policy since the late 1980s and early 1990s (Forder 2005). According to Maxfield (1998), during the 1990s, legislations in favor of central bank independence passed in 30 countries, while this number was six during the 1960s, eight during the 1970s, and three during the 1980s.

The international monetary regime also had a significant influence on the conduct of central banks. Helleiner (1996) explicates that during the prevalence of the Bretton Woods system, states were allowed to adopt fixed exchange rate regimes and extensive capital controls. The liberal international financial system after the end of the Bretton Woods system allowed free capital movements in large scales, flexible exchange rate regimes, and a new international financial system with more volatility and uncertainty (Chwieroth 2009). This new non-system enabled central banks to play a more influential role in the conduct of monetary policy and central banks such as Bank of England and Fed have contributed to the ‘financialization’ of the global economy by making markets more susceptible to their policy implementation methods (Walter & Wansleben 2019).

Schenk and Straumann (2016) classify international monetary regimes in terms of their sustainability and suggest that the interwar gold standard, the Bretton Woods system, and the floating exchange rate regime from 1973 to 1979 were not sustainable because either the leading economic powers pursued divergent economic policies or the lack of central bank independence was insufficient to deal with exogenous shocks. On the other hand, they classify the classical gold standard and the floating exchange rate regime from 1979 to the present as stable regimes, because either there was an international consensus on economic policy, such as the classical gold standard, or the central banks had gained independence so that they had their tools to utilize (Schenk & Straumann 2016, p. 322). These international dynamics influenced the tools central banks possessed to achieve their objectives.

Krampf (2013) reviews the historically dominant policy norms in central banking and suggests that the liberal and developmental norms were prominent during the 20th century. The liberal norm prioritizes liberalized financial systems, free capital flow, full exchange convertibility, and price stability seeking independent central banks. On the other hand, the developmental central banking norm emphasizes managed exchange rates, capital controls, and preferential credit allocation for development objectives. Under the influence of developmental central banking norm, central banks are supposed to have extensive administrative instruments to control the banking system and manage the allocation of resources. The liberal central banking norm emerged in Europe and spread throughout the world with the critical role played by the Bank of England, Bank for International Settlements, the Bundesbank, the Organization for Economic Cooperation and Development (OECD), and the International Monetary Fund (IMF). The developmental central banking norm, in contrast, emerged in Latin America and diffused to East Asia with the help of Fed officials but ultimately lost its appeal with the dominance of the liberal norm since the late 1970s. Cobham (2018) classifies the monetary policy frameworks in advanced and emerging economies and finds that through time the emphasis of central bankers in both groups of countries has shifted more towards inflation targeting with less focus on exchange rates and monetary aggregates. Despite this shift, Wong and Chong (2019) find no positive effect of inflation targeting on growth.

There are different explanations on the prominence of central bank independence. Maxfield (1998) argued that the governments in emerging economies were interested in attracting foreign investment, and a concern to send a credit worthiness signal to international investors led them to implement central bank independence reforms. McNamara (2002)...

Table of contents

• Cover
• Half Title
• Series
• Title
• Copyright
• Contents
• List of contributors
• Preface
• 1 Introduction: political economy of central banking in emerging economies
• Part 1 Global influences on central banking in emerging economies: debates on central bank independence and institutional evolution in national economies
• Part 2 Central banking in the European periphery
• Part 3 Central Banking in Africa
• Part 4 Central Banking in Latin America
• Part 5 Central Banking in Asia
• Index