Central Bank independence vs Central bank accountability to society: Why Czechs have preferred low inflation?

Nice speech by Mojmír Hampl, former Vice Governor of Czech National Bank. He says central bank independence is more than just codifying it in law. The central bankers have to act independently and be accountable to society they serve.

Few economists nowadays doubt the importance of central bank independence for achieving price stability. For example, the latest meta-analysis of this research question summarizes 300 empirical estimates from dozens of studies and finds strong evidence that independence is crucial for delivering low inflation (Iwasaki and Uegaki, 2017). This finding holds for both developed and emerging economies, as the authors clearly show.

But many economists in this stream of literature, most prominently Alex Cukierman, stress that it is not enough to have independence enshrined in the central bank’s charter. Legal independence is a necessary condition for actual independence, but not a sufficient one. I would say that actual independence is a state of mind of central bankers. This state of mind, then, determines the outcome of monetary policy and is imperative for providing price stability.

So how can actual independence differ from legal independence? The key condition for actual independence is the de facto impossibility to dismiss central bank board members. In fact, the charters of almost all central banks around the world (including the National Bank of Ukraine and the Czech National Bank) allow for board members to be dismissed under some very specific conditions. But the applicability of these conditions varies widely, depending on custom and – crucially, I believe – the central bank’s standing in society.

This observation brings me to an important point I want to make. Even if a central bank is actually independent from the government, it cannot over the long term act in direct contradiction to the preferences of society. For example, if the population is not averse to modest inflation, the central bank will have a hard time imposing an ultra-low-inflation environment, with all the associated costs and benefits, over the long run.

He goes on to say why things are different in Czech?

The experience of the Czech National Bank, perhaps, serves as a case in point, although in the opposite direction. In general, Czechs despise inflation, and the central bank needs to explain repeatedly why it uses the worldwide standard of a 2% inflation target instead of targeting literal stability of the CPI level, or 0% inflation. Already many decades before the era of independent monetary policy, in the early 1920s, Czechoslovakia pursued a strategy of deliberately strengthening the national currency. This policy resulted in deep deflation, in strong contrast to the hyperinflations seen at that time in neighboring countries (Austria, Germany, Hungary, and Poland; see Sargent, 1982).

So, it comes as no surprise that the Czech National Bank is rarely applauded for cutting interest rates, while hikes are often welcomed by a majority of the population. An important public-relations test arose for the Bank in 2013, when interest rate cuts proved insufficient to return inflation to the target. Inspired partly by one distinguished member of today’s panel, the Czech National Bank adopted an exchange rate commitment to keep the currency from appreciating.

The commitment was terminated a year ago. Since then, studies by the IMF and academics alike have pointed to large benefits of the policy in terms of reducing unemployment, lifting GDP growth, and preventing deflation. Within two years after the commitment’s enactment, the Czech Republic – at least in part thanks to the commitment – turned from a de facto sick man of Europe to one of the fastest-growing economies with the lowest unemployment rate in the entire EU.

What was intriguing was what led Czechs to value low inflation? It was a long fight by their finance minister Alois Rašín who preferred deflation in early 1920s when countries like Austria and Germany headed for hyperinflation:

enhancing financial literacy and altering public preferences in the process is a thankless, tiresome, long-term job, one that is often only appreciated years or even decades later. The man responsible for instilling a low-inflation mentality in Czechs, Alois Rašín, was shot dead in 1923 by a young communist. At that time, Rašín’s policies were very unpopular among some groups of the population. But nowadays his legacy underpins the thinking of Czechs about inflation, for better or worse, and through that, the stability of the Czech currency.

Some more history of how Czechs followed their history.


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