Central Banking Note

1.
Measuring Central Bank Independence

Independence is a continuous, not dichotomous, and variable. In other words, there
are degrees
Of central bank independence. Defining and measuring the degree of independence
is not a
Simple task, because independence can be enhanced or undermined in a variety of
ways.
There are two general ways to measure independence1. one behavioral,
2. The other formal.
Woolley, for example, uses a behavioral definition. "A central bank," he argues, "is
Independent if it can set policy instruments without prior approval from other actors
and if,
For some minimal time period (say, a calendar quarter), the instrument settings
clearly differ
From those preferred by other actors." One therefore looks to autonomous behavior
as a
Sign of independence.
But I prefer to define independence formally, in terms of the laws governing the
organization and operations of a central bank, because changes in laws and
statutes provide a means to specify more precisely when an actual shift in central
bank independence occurs. Seeking to specify independence formally, Bade and
Parkin identified three dimensions1. The assignment of responsibility for monetary policy,
2. The sources of appointment of bank governors,
3. and their terms of office-as being critical in measuring the degree of
central
bank independence.
In general, they argue, central banks enjoy greater independence where They are
assigned the legal authority to both set and implement monetary policy.
Independence is also enhanced in countries where a majority of bank directors is
not directly appointed by the central government and where the directors enjoy
lengthy tenure in office. Of course, a central bank which appears to be formally
independent might still face significant pressures to adopt policies favorable to the
government, especially regarding the financing of its deficits.
For this reason, I incorporate two other dimensions
1. Limits on direct central bank financing of government deficits (through
a current account) and
2. Limit son central bank purchases of government bills. Explicit limits on
the extent to which a
Central bank can or must monetize government deficits through either
facility bolster its
Ability to resist government demands to stimulate the economy.
More recently Grilli, Masciandaro, and Tabellini (1991) construct a related measure
of central bank independence that reflects both "political independence" and
"economic independence." Political independence is defined essentially as

in Bade and Parkin (1982), as the ability of the central bank to select its
policy objectives without influence from the government. This measure is
based on factors such as whether or not its governor and the board are appointed
by the government, the
length of their appointments, whether government representatives sit on the board
of the bank, whether government approval for monetary policy decisions is required
and whether the "price stability" objective is explicitly and prominently part of the
central bank statute. "Economic independence" is defined as the ability to
use instruments of monetary policy without restrictions. The most common
constraint imposed upon the conduct of monetary policy is the extent to which the
central bank is required to finance government deficit. This index of economic
independence essentially measures how easy it is for the government to finance its
deficits by direct access to credit from the central bank.
Table: summarizes these five dimensions of central bank law in France, Italy, and
West
Germany.
2. Preparation of Monetary Policy in Bangladesh

As part of the responsibility, as per Section 7A of the Bangladesh Bank Order 1972,
Bangladesh
Bank formulates and implements monetary policy each year. As stated in the
preamble of the Bangladesh Bank Order 1972 amended in 2003, the objective of
monetary policy of Bangladesh is to stabilize domestic monetary value (i.e. low
inflation) and maintain a competitive external par value of the Bangladesh Taka (i.e.
a competitive exchange rate) towards fostering growth and development of
countrys resources in the best national interest. Within the legal context,
Bangladesh Bank generally focuses on achieving price stability along with moderate
inflation while providing sufficient space in its monetary program for domestic credit
which supports broad based investment and inclusive growth objectives. The aim of
the central bank is to ensure a congenial environment of output growth by providing
a stable macro platform with moderate inflation and a largely stable. Bangladesh
Bank conducts its monetary policy through a monetary policy framework which
refers to a logical and sequential set of actions. It wants to achieve certain goals but
cannot directly influence the goals. It has a set of tools at its disposal that can affect
the goals indirectly in a lagged fashion. So, if the central bank waits to see the
effect of the tools on the goals, it will be too late to make necessary corrections to
the policy. That is why it aims at some variables that lie in between the tools and
goals which it can change and monitor very shortly. Thus, Bangladesh Bank like
other central banks decides on the strategy for conducting monetary policy. The
variables that Bangladesh Bank generally addresses can be classified as
instruments, targets
and goals. The framework can be expressed in a flowchart as shown below
The targets are further classified as operational targets and intermediate targets.
Bangladesh Bank also keeps an eye on some developments of the major macro
variables such as GDP growth, inflation, growth of monetary aggregates and
liquidity position of banks, short-term interest rates, and exchange rates to make
any policy revision. The core action space of any central bank in a developing
economy can be described in the Activity Pentagon of Monetary Policy as shown in
the inner page of the back cover. The two variables of the Pentagon such as the
interest rate and money growth are usually used as operating targets while inflation
and the exchange rate in the middle stage are often treated as intermediate
targets. Achieving sustainable growth turns out to the final target in the activity
space of monetary policy.
Bangladesh Bank like every central has a limitation in achieving its goal because it
has to assume a stable money demand function which may vary depending on
other situations. Bangladesh Bank works on high-powered reserve money with the
assumption that the money multiplier will remain the same. But it varies. For
example, during the Great Depression, the Federal Reserve of the US increased
high-powered money (monetary base). But ultimately the Fed was blamed for
monetary contraction because the money multiplier fell drastically, making the
growth of money supply negative. Thus, monetary policy turns out to be a difficult
exercise on the part of the central bank.
This monetary policy mainly features:
An
An
An
An
inflation controlling money growth strategy

internal demand boosting monetary plan
investment friendly monetary path
inclusive growth framework
Bangladesh Bank designs the Monetary Policy Stance for January-Jun 2015 based on
the changes in the global scenario as well as developments in the domestic
economy.
Global and Regional
Outlook
The Domestic Sector

Inflation Scenario
GDP Growth Performance
Developments in Public
Finance
Annual Development
Program
Government Borrowing
The Monetary and

Financial Sector
Lending Rates and Deposit
Rates
Banking Sector
Performance
Capital Market
Developments
Quantity Theory of Money

An economic theory which proposes a positive relationship between changes in the
money supply and the long-term price of goods. It states that increasing the amount
of money in the economy will eventually lead to an equal percentage rise in the
prices of products and services. The calculation behind the quantity theory of
money is based upon Fisher Equation:
Calculated as:
Where:
M represents the money supply.
V represents the velocity of money.
P represents the average price level.
T represents the volume of transactions in the economy.
This theory originated in the sixteenth century as European economists noticed
higher levels of inflation associated with importing gold or silver from the Americas.
According to how the formula is derived, holding the transaction volume

and velocity of money constant, any increases in the money supply will yield a
proportional increase in the average price level.
Monetarism-A set of views based on the belief that inflation depends on how much
money the government prints. It is closely associated with Milton Friedman, who
argued, based on the quantity theory of money, that the government should keep
the money supply fairly steady, expanding it slightly each year mainly to allow for
the natural growth of the economy.
it is a macroeconomic school of thought that emphasizes (1) long-run monetary
neutrality, (2) short-run monetary nonneutrality, (3) the distinction between real
and nominal interest rates, and (4) the role of monetary aggregates in policy
analysis.

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1.

Measuring Central Bank Independence

"economic independence." Political independence is defined essentially as

2. Preparation of Monetary Policy in Bangladesh

and goals. The framework can be expressed in a flowchart as shown below

inflation controlling money growth strategy

The Domestic Sector

The Monetary and

Quantity Theory of Money

According to how the formula is derived, holding the transaction volume

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