Central banks are for long term, unlike govts: RBI deputy governor

A central bank that is independent from the executive branch of the government is important for a well-functioning economy and any move to undermining the central bank’s independence are potentially catastrophic, a “self-goal” of sorts, as it can trigger a crisis of confidence in capital markets that are tapped by governments (and others in the economy) to run their finances, Reserve Bank of India deputy governor Viral V Acharya has said.

While the world over, the central bank is set up as an institution separate from the government, political expediency sometimes forces governments to consider it as a department of the executive function, forgetting its powers are enshrined as being separate through relevant legislation. 
The tasks of a central bank are somewhat complex and technical, central banks are ideally headed and manned by technocrats or field experts – typically economists, academics, commercial bankers, and occasionally private sector representatives, appointed by the government but not elected to the office. And this explains why central banks should be allowed to exercise their powers independently, he pointed out.
“A government’s horizon of decision-making is rendered short, like the duration of a T20 match (to use a cricketing analogy), by several considerations. There are always upcoming elections of some sort – national, state, mid-term, etc. As elections approach, delivering on proclaimed manifestos of the past acquires urgency; where manifestos cannot be delivered upon, populist alternatives need to be arranged with immediacy. Less important in the present scenario, but only recently so, wars had to be waged, financed and won at all costs. This myopia or short-termism of governments is best summarized in history by Louis XV when he proclaimed “Apres moi, le deluge!” (After me, the flood!).”
“In contrast, a central bank plays a Test match, trying to win each session but importantly also survive it so as to have a chance to win the next session, and so on. In particular, the central bank is not directly subject to political time pressures and the induced neglect of the future; by virtue of being nominated rather than elected, central bankers have horizons of decision-making that tend to be longer than that of governments, spanning election cycles or war periods. While they clearly have to factor in the immediate consequences of their policy decisions, central bankers can afford to take a pause, reflect, and ask the question as to what would be the long-term consequences of their, as well as government’s, policies. Indeed, by their mandate central banks are committed to stabilise the economy over business and financial cycles, and hence, have to peer into the medium to long term. Unsurprisingly, central banks strive to build credibility through a series of difficult choices that reflect sacrificing short-term gains for long-term outcomes such as price or financial stability.”
He drew the analogy of Martin Redrado, who resigned as Argentina’s central bank chief, telling a news conference on 29 January 2010 that he decided to quit the organisation as it lost its independence.
“My time at the central bank is up and that is why I have decided to leave my post definitively, with the satisfaction of my duty fulfilled,” he said.
“We have arrived at this situation because of the national government’s permanent trampling of institutions,” he said. “Basically, I am defending two main concepts: the independence of the central bank in our decision-making process and that the reserves should be used for monetary and financial stability.”
The governor decided to quit after the Cristina Fernandéz government of passed an emergency decree on 14 December 2010, to set up a Bicentennial Stability and Reduced Indebtedness Fund to finance public debt maturing that year. This involved the transfer of $6.6 billion of the central bank reserves to the national treasury. The claim was that the central bank had $18 billion in “excess reserves.” As Redrado refused to transfer the funds, the government attempted to fire him, by another emergency decree on 7 January 2010 for misconduct and dereliction of duty. But this attempt failed, as it was unconstitutional.
Besides sparking off one of the worst constitutional crises in Argentina since its economic meltdown in 2001, the chain of events led to a grave reassessment of its sovereign risk.
Within a month of Redrado’s resignation, Argentine sovereign bond yields and the annual premium cost for buying insurance against loss from default on Argentine government bonds (measured as the sovereign credit default swap spread) shot up by about 250 basis points ,or by more than a fourth of their prior levels.
More damaging was the freezing of Argentine central bank’s account held at the Federal Reserve Bank of New York by Thomas Griesa, a New York judge, following claims of investors that the central bank was no longer an autonomous agency but under the thumb of the country’s executive branch.\
Inclusive economic and political institutions involve plurality in decision-making which help guarantee the rule of law and foster talent and creativity; in the presence of such institutions, economics and politics do not become hostage to a set of incumbents likely to be hurt by change.
In contrast, he said, extractive institutions limit access to a country’s economic and financial resources to the ruling elites, hinder change and innovation, and over time, lead to stagnation and atrophy of the country’s potential.
Democracies across the world acknowledge the importance of property rights and their enforcement, the judiciary, and the election office, instituted not just de jure but allowed to operate independently and function effectively de facto.
However, the institution of an independent central bank may look less important, perhaps not just because the central bank is a relatively new kid on the block (in most cases less than a century old), but also because it interacts less directly with the public though its true influence is far-reaching.
A central bank performs several important functions for the economy: it controls the money supply; sets the rate of interest on borrowing and lending money; manages the external sector including the exchange rate; supervises and regulates the financial sector, notably banks; it often regulates credit and foreign exchange markets; and, seeks to ensure financial stability, domestic as well as on the external front.