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The Autonomy of Bangladesh Bank

ECO 432 Term Paper

Submitted by:

Sardar Mohammad Imrose Sumaiya Mahabub

Kazi Sakif Zaman Reza Maria Matin

Samiha Moyeen

Table of Contents

Introduction:.........................................................................................................................................3Background:..........................................................................................................................................3Theory of Autonomy:..........................................................................................................................4

What is Autonomy?................................................................................................................4

The Rogoff-Conservative Model:.......................................................................................5

Measuring Autonomy: ..........................................................................................................6

The Legal Measure:...............................................................................................................6

The GMT Index....................................................................................................................6

Central Bank Independence and Governance:................................................................. 8

Advantages and Disadvantages of Autonomy:..............................................................9

Relationship in Developing Nations:...............................................................................9

History of Central Banks’ Autonomy: ............................................................................................10Does Bangladesh Bank have Autonomy in the True Sense?.......................................................11The Political Autonomy of Bangladesh

Bank..............................................................12

The Economic Autonomy of Bangladesh Bank .........................................................14

Case Study: The Reserve Bank of Australia & Bangladesh Bank ...............................................18Bangladesh Bank

Reforms:...............................................................................................18

The Reserve Bank of Australia Reforms: ...................................................................... 19Frameworks of Reserve Bank of Australia’s Reform:................................................20

Data Comparison:................................................................................................................21

Recent Trends and Observations: ................................................................................................... 26

Some Positive Trends.......................................................................................................... 27

Some Negative Trends ....................................................................................................... 30

Inflation in Bangladesh...................................................................................................... 31

Conclusion and Policy Recommendation.......................................................................................33

References:.......................................................................................................................................... 34

The Autonomy of Bangladesh Bank

Introduction:

It is sometimes criticized there is a glass wall around the Bangladesh Bank whichprevents it from being independent – BB is only autonomous by name but

not in practice.The purpose of this term paper is to identify whether BB is actually autonomous or not; ifyet, then to what extend – both in theory and in practice; and then see the effects of theirpolicies in recent economic trends to recommend some policy for future developments. Thefollowing order will be maintained to facilitate the understanding of this paper: Background of Bangladesh Bank

Theoretical Aspects of Autonomy

History of Central Banks’ Autonomy around the World

The Identification of the Extend of Independence of Bangladesh Bank

Case Study of the Reserve Bank of Australia to Observe the Practical Benefits ofCentral Bank Autonomy and Compare with Bangladesh Bank

Observe Recent Trends to Construct Conclusion

Policy Recommendations.

Background:

The Bangladesh Bank is the central Bank of Bangladesh. The governor is Dr. AtiurRahman with a board of directors consisting of himself as the chairman, 8

directors, and 1secretary to assist him. The vision of the Bangladesh Bank is: “To develop continually as aforward-looking central bank with competent and committed professionals of high ethicalstandards, conducting monetary management and financial sector supervision to maintainprice stability and financial system robustness, supporting rapid broad based inclusive

economicgrowth, employmentgenerationand poverty eradicationin Bangladesh”

(Bangladesh Bank). The main functions of BB are:

Formulating monetary and credit policies;

Managing currency issue and regulating payment system;

Managing foreign exchange reserves and regulating the foreign exchange market; Regulating & supervising banks and financial institutions, & advising the governmenton interactions & impacts of fiscal, monetary & other economic policies.

Now that we have given a brief introduction of Bangladesh, we shall start analyzing theinterested topic. For understanding the effects of autonomy, we first need

to understandwhat autonomy for central banks actually mean. In the following section, the theoretical andhistorical account of central bank autonomy will be elaborated.

Theory of Autonomy:

What is Autonomy?

The term autonomy, or independence, in context of Central Banks, refers to how freelythe monetary policy makers can conduct policies with little or no

interference from thegovernment.Also referred to as the “autonomy” of Central Banks, the definition of

independence considers two important aspects. They are political independence andeconomic independence (concepts elaborated later on in the chapter in relation toBangladesh), However,nowadaystheseaspectshave more popularnames: “Goal

independence”, “Target independence” and “Instrumental independence” (Lybek).

Table # 1: Types of Independence

Goal Independence:

Allows the Central Bank to decide its own monetary goal and/or exchange rate system, exclusive to the directinfluence of the politicians. In the case of a floating exchange rate system, the central bank solely concentrateson the monetary policy. Some common monetary goals are maintaining price stability, controlling moneysupply or increasing real growth in the economy

Target Independence:

When the central bank is goal dependent, i.e. the state decides the macroeconomic objectives, it lets the centralbank set the target value to the goal and to come up with the policy instruments with which it will achieve thetarget. For instance, if the state wants to keep the inflation rate at a low level of 2 percent, it will probablyadopt a contractual monetary policy where the interest rate is set at a very high level

Instrumental Independence:

This is probably the least independent dimension among the three that we have been discussing. Thegovernment “consults” the central bank and sets the monetary target. The Central Bank is said to beinstrumentally independent as it is free to choose the policy tools to attain a macroeconomic goal. Besides that,it is both goal dependent and target dependent on the government. The instruments applied by the bank are:Open-market operations, discount lending and reserve require

The Rogoff-Conservative Model:

When modeling the independence of a central bank, the Rogoff-conservative centralbank model should be mentioned. In this model, the weight placed on

inflation determinesindependence. When the central bank places a heavier weight on the inflation rate than thegovernment, the bank is referred to as a “Rogoff-Conservative Central Bank:. This exhibitsboth goal independence and instrument independence, because first, the bank wants toreduce the inflation rate to a level much lower than that favoured by the government.Second, it can freely use desired monetary tools necessary to achieve the target inflation rate.

In an alternate model, the Central bank’s monetary objectives are weighted against thegovernment’s objectives. For example, if the central bank supports a real

output target whichis feasible with the natural rate of unemployment in the economy but lower than the targetbacked by the government. The bank has complete independence if the actual target is closerto the bank’s target and if no weight is placed on the government’s objectives. Conversely,the bank has no independence if the actual is heavily weighted on the government’sobjectives.

.

Measuring Autonomy:

There are several index and formulas derived to measure centre bank autonomy. For thispaper, we can to elaborate on three specific measurements or criteria:

i. Legal Measure by Cukeiman, Webb, and Neyapti

ii. GMT Index by Alesina, Masciandaro, and Tabellini

iii. Central Bank Independence and Governance (CBIG)

The Legal Measure:

According to Cukierman, Webb, and Neyapti (1991), the legal measure of independenceof a central bank is based on four criteria-

I. Appointment of chief executive: A bank is viewed to be more independent if the chiefexecutive is appointed by the central bank and not the prime minister or

thefinance minister, and has a long term of office.

II. Government involvement in policy decisions: the independence is greater as the policydecisions are made with less and less participation of the government.

III. Goal of monetary policy: When price stability is given the maximum priority, a bank issaid to have a high level of independence.

IV. Government borrowing from central bank: Finally, the level of independence is greater ifmore restrictions are placed on the ability of the government to borrow

from thecentral bank.

The GMT Index

Messrs Grilli, Masciandaro and Tabellini via their formulated index called the GMTindex (1991) measures the independence of central banks. This index, with

the contributionsof Cukierman (1992) divided the autonomy of Central Banks into two parts: PoliticalAutonomy and Economic Autonomy. Each of these was to be subdivided into multiple categoriesas follows:

Political Autonomy Criteria:

i. Appointment of the Governor of the Central Bank without any influence of

the Government.

ii. Governor of the Central Bank to be appointed for tenure of more than five

years.

iii. Members of the Board of Directors to be appointed without government

influence.

iv. Board members to be appointed for more than five years.

v. There are no provisions where the government decides on who represents

the board.

vi. There are legal provisions aimed to protect during conflict with government.vii. No need for to seek approval in devising monetary policy.

viii.The charter must include provisions aimed to seek monetary policy stability

as its core objectives.

Economic Autonomy Criteria:

i. Easy credit to government at market interest rate.

ii. Credit is extended on a temporary basis.

iii. Central Bank does not participate in the primary market for public debt.

iv. There must be a limit on government borrowing from the central bank.

v. There are no automatic procedures for the government to obtain direct

credit from central bank.

vi. Central Bank sets the discount rate.

vii. Central Bank has no role to oversee the banking sector/share this role with

another organization.

There are a number of criterions that must be considered to assess the degree ofautonomy of any Central Bank. Should any of these are fulfilled, a point is

awarded. Basedon these values the respective indices are constructed (political and economic) which arethen averaged to get an overall rating of a central bank. The higher the score, the moreindependent a central bank is.

Central Bank Independence and Governance:

The Central Bank Independence and Governance (CBIG) Index is a measure of thefreedom from political and financial market pressures that the central

bank can pursueduring its operations. Several models have been brought forth by different authors but themodel suggested by Ahsan, Skully, Wickarmanayake (2006, p.60) best predicts the CBIGIndex. It is as follows –

CBIGOverall= w CBIG1 Leg+w CBIG2 Pol+w CBIG3 PStab+w CBIG4 Forx+w CBIG5 MonPol+w CBIG6 AccTrans

Where,

CBIGLeg= Legal Index of CBIG (measures the independence that a central bank is granted by its acts)CBIGPol= Political Index of CBIG (measures the political influence on the central bank operations)CBIGPStab= Price Stability Objectives Index of CBIG (is the guideline provided to the central bankto consider price stability as its main monetary policy objective)

CBIGForx= Exchange Rate Policy Index of CBIG (refers to the function of the central bank under afixed and a floating exchange rate system)

CBIGMonPol= Monetary Policy and Deficit Financing Index of CBIG (refers to the devising ofmonetary policy, choosing the final target and regulating the government

budget financing)CBIGAccTrans= Accountability and Transparency Index of CBIG (the imposition of the rule thatthe central bank is bound to disclose its policy changes and monetary policy

statements to the public)

Weight = w1= 5/26; w2= 3/26; w3= 3/26; w4= 3/26; w5= 6/26; w6=6/26

Advantages and Disadvantages of Autonomy:

The following table summarizes the pros and cons of autonomy:

Table # 2: Pros and Cons of Autonomy

Advantages Disadvantages

Greater goal and instrument independence produces lower average inflation. Low prices signify a favorable effect on the economy

Complete independence is seen as a threat, questions the accountability of the central bank. Maintaining a low and stable inflation isn’t the only issue of concern

Absence of political influence allows the prices to be stable

Legal measures do not indicate the actual relation between the central bank and the govt. Gap is huge in developing nations. Alternate measure by Cukierman: governor turnover

Positive correlation between inflation and governor turnover in developing nation.

Relationship in Developing Nations:

Governor turnover measures how frequently a central bank changes its governors. Theshorter the term in office, the stronger is the involvement of the

government in the centralbank’s operations, the less is the independence of the bank. In developing countries, there isa positive correlation between inflation and governor turnover. Advocates of independencewould say that this is a strong evidence of how the government’s interference in the centralbank prevents the bank from making proper decisions regarding price stability. But othersraise questions as such: Is it the political involvement that is producing high inflation or arethe governors being fired because they are inept at controlling the inflation?

History of Central Banks’ Autonomy:

During the 1950’s, there was a financial crisis where the Federal Reserve had lost itsindependence and so did the Bank of England. In 1951, it regained its

independence and thepolicy of independence was quite successful on lowering average prices.

Under the Bretton Woods era (mid 20th century), which was the post war period, the

countries were committed to fixed exchange rates so they could not conduct efficientmonetary policy. At the time, their goals were constrained by the gold convertibility. Thisperiod has high inflation, and because of the gold convertibility problem, the banks couldnot use monetary policy or set their goals and targets. This again strengthens the fact thatcentral bank independence is a primary determinant of a country’s inflation. After this periodwhen some major central banks like the European Central Bank and the US Federal Reserve,went for central bank independence, their policies and goals resulted in sufficient lowering ofthe average rate of inflation. After this in the 1990’s many developing countries adoptedcentral bank independence.

From the brief survey of the histories of the Bank of England and the Federal Reserveseveral policy lessons can be discerned.

First, central bank independence can be helpful in dealing with financial crises. This wasthe case in Western Europe during the classical gold standard era. The

Bank of England andits counterparts in Western Europe as publicly chartered banks of issue effectivelymaintained a credible nominal anchor and served as an effective lender of last resort to thefinancial system. They operated in a rules based regime. Second, based on the experience ofthe Federal Reserve in the interwar period, central bank independence can be harmful if it isbased on a flawed policy doctrine or a structurally flawed institution.

As mentioned previously, there are mainly three types of independence: -goal

independence, target independence and instrument independence. Studies show that a bank

cannot have all three kinds of independence simultaneously. They mostly have any one ofthe three. If we look at UK, the Bank of England lacks goal independence. This is becausethe country’s inflation rate is set by the government. The Bank of England, even though itlacks goal independence, it has high instrument independence because it is able tomanipulate its instruments and set its tools without the interference of the government. Onthe other hand if we look at the US Federal Reserve, the goals are set by a legal charter, butthey are very vaguely described, thus, they translate these goals themselves into operationalgoals.

When the banks are not independent, certain targets for the policy is set politically, sothe Banks will choose the best means to achieve that target. The importance

of central bankindependence comes to the forefront here primarily because politicians may seek to compelthe central bank to adopt measures that although in the short-run may boost economicgrowth, in the long run will lead to an undesirable rise in inflation. Economic growth willmeanwhile return to its original level, or even sink to a lower level (as a result of the higherinflation). A sufficient degree of independence from political influence allows the centralbank to resist such pressures.

Does Bangladesh Bank have Autonomy in the True Sense?

As considerable time and effort has been assigned to the history and the current state ofcentral bank autonomy all over the world, we may now focus on the

independence of BangladeshBank (i.e. the central bank of Bangladesh); its respective degree and its subsequent causes.Such will be achieved with the help of a model unearthed in various literatures relating to thetopic in question. This will later be followed by the observations and outcomes which hadgiven rise to such a result.

As we analyze Lybek’s definition of the autonomy of a Central Bank, we find thatBangladesh Bank fall under the category of Target autonomy. This, being

one of the broaderforms of autonomy may project Bangladesh Bank to be relatively self-ruling. However such

a statement may prove to be otherwise as the definition proposed by Lybek focuses on the“monetary policy aspects and not on the supervision and regulation of the financial sector”(Ahmed, 2009). This is particularly significant in the case of Bangladesh owing to the factthat whatever provisions might there be on paper may not necessarily be applicable (or moreimportantly enforceable) in actual terms. To consider the operational aspects of BangladeshBank’s autonomy along with its planning, there was a need to adopt a model moreappropriate and able to weigh in the dynamics of the Bangladeshi scenario. The answerwould be found in the works of Messrs Grilli, Masciandaro and Tabellini via theirformulated index called the GMT index (1991). The following tables will be analyses of BB’sperformance and the graphical representation of the GMT Index.

The Political Autonomy of Bangladesh Bank

Table # 3: Political Autonomy in Bangladesh Bank

Observations from Table # 3:

The Governor who is the Chief Executive Officer of the Bangladesh Bank is also thechairman overseeing the Board of Directors of the institution. His appointmenthowever is made directly by the government and for tenure of four years therebyleading to a score of zero in the first two criterions. It may be added that theappointment of the one in focus has not been in a situation where “competentcandidates for the post of governor are officially short- listed and the list madepublic” (Ahmed, 2009).

As in the case of the Board of Directors of BB, there are to be nine membersincluding the Governor, of which four are to be from a civil society and three are tobe from the executive panel of the government. This explains nought values forpoints three and four. In addition the fact that the tenure of board members fromthe executive bench is to remain at the discretion of the government (point 5)reduces political autonomy to a greater degree.

The analysis of the sixth point will be discussed later as it coincides with argumentsstated afterwards. The last two criterions will not be discussed as BB is alreadyfulfilling them.

Analysis:

1) The inclusion of members from the executive bench in the Board has raised manyeyebrows amongst many specialists in this arena. This arises from the ironic situationthat the government is appointing its own agents (i.e. the exec members) to ensurethat the goals of the government are realized by those whom the government hadappointed (the governor and from the civil society) as those most capable anddeserving for the position. Such a predicament also has had an adverse effect on thetransparency of the monetary body. This is owing to occurrences where the politicalentities in the board have used their influence to promulgate decisions which weremore beneficial to the incumbent government’s political agenda and less to theeconomic benefit of the nation (in the long run). Examples include cases where loanshave been rescheduled for loan defaulters who were aspiring to stand under thebanner of the ruling party in the National elections (Ahmed, 2009).

2) As capable as the appointed governors may be there has not been an instance whereone has been reappointed (which is possible under law if he/she is below 65 years ofage). In other words there has been a new governor every four years. Such trends inthe change in governors and the political victory of an alternate party (AL/BNP) areuncanny. These regular alternations have also led to a high value of governor turnoverwhich is not advised in developed nations.

3) The Bangladesh Bank seems to have inherent restrictions in the in the financing ofits operations too. One is able to state as such as the BB has to rely on the

deliberation of the Ministry of Finance for issues such as pay rises of its employees.This is despite the fact that the BB prepares its own budget and has its own sourceof earnings (Bangladesh Bank Order, 2003).

The Economic Autonomy of Bangladesh BankTable # 4: Economic Autonomy of Bangladesh Bank

Observations from Table # 4:

The first three criteria are the ones that should be of most importance as it providesa clearer picture regarding the dependence of the Bangladesh Bank in the financialsector. In the case of credit provision, one sees that Bangladesh Bank has little on itsway to control the flow of credit to the government or the ability to provide them atrates which are relatively favorable compared to market rates (point 5).

Analysis:

1) A vital factor in assessing the degree of economic autonomy of any central bankwould be to monitor its provision of credit to its own government. In the case ofBB, it emerges that BB does not have the authority to restrict such flows of money(Financial Sector Review, 2006, p.74). The following data gives a clearer picture:

Source: Bangladesh Economic review, 2005, MoF, GoB

The chartabovehighlightsthat therehas beensignificantincreasesin

government borrowing since 1995-1996. Incapacity of the government to meet itsrevenue targets followed by reductions in foreign aid has left with the governmentrelying heavily on the BB. These huge amounts of credit were funded via the BB’sexpress participation in the primary market (criteria 4, economic autonomy). Suchactions have had repercussions on the effectiveness of the BB as the reduced moneysupply not only diminishes the effectiveness of future monetary policies but also

increases the risk of a crowding-out effect in the ‘private sector credit’ (Ahmed, 2009).Many have voiced their collective opinion that there should be amendments made inthe charter of the BB to vest it with powers to deny such favors in the interest of theeconomy.

2) A significant portion of the loans have been allocated to numerous public- sectorenterprises (e.g. Bangladesh Petroleum Corporation) of which most perform poorlydue to the existenceof politicized unions, substandard assetand liquidity

management and problems related to human resource management. This makesthese institutions contribute to the “largest share of Non-performing asset” of BB(Bangladesh Bank Annual Report 2004-2005). According to INVESTOPEDIA anon performing asset is a debt obligation where the borrower has not paid anypreviously agreed upon interest and principal repayments to the designated lenderfor an extended period of time. The nonperforming asset is therefore not yieldingany income to the lender in the form of principal and interest payments.

As the criterions pertaining to the GMT Index have been discussed extensively, we cannow have a final look at the index itself. The following graph describes

how the BB’sautonomy fares with the rest of the world. Included in the chart are the autonomy indexes ofthree broad classes: advanced economies, emerging markets and developing countries:

Graph # 1: Bangladesh Bank Autonomy – Comparative Perspective

Source: BB reform: changes and challenges, 2006, p.18

Calculation: Political Index= (2/8) =0.025

Economic Index= (1/7) = 0.143

BB Autonomy GMT Index= (0.25+0.143)/2 = 0.196

As commented by Ahmed in his paper, the results of the BB’s autonomy are suggeststhat it is lagging behind even in comparison to the central banks of

developing economies(ie, India, Sri Lanka, Pakistan, etc). Additionally it is only the case of the BB where the meanscore of the economic index is lower than that of the political index. This goes on to supportprevious arguments that there is an excess of political influence in the functioning of the BBcompared to its foreign counterparts. Whether or not increased independence will benefitBangladesh is a completely different issue and the subsequent sections of this paper willfocus on this.

Case Study: The Reserve Bank of Australia & Bangladesh Bank

Now that we have a firm understanding of Independence of the central bank, lets focuson its implications on the central bank of Bangladesh (Bangladesh Bank –

BB). However,before delving into scrutiny we are to derive some basic principles from a country which hasalready undergone autonomy of its central bank and has been successful in devising itsmonetary policies. For availability of data, and the amount of research work already done inthis topic, we’ve chosen the central bank of Ausralia (Reserve Bank of Australia – RBA)which, in our opinion, befits the purpose of our research as we can see the explicit benefitsof central bank autonomy. This segment of the paper thus compares the central bank ofAustralia (a developed nation) to the central bank of Bangladesh (a least developed nation).

The comparison will be carried out mainly in two forms. First, we are to see whether acountry with higher GDP per capita and lower inflation rate also has a

higher CBIG (CentralBank Independence and Governance) than that of a country with lower GDP per capita andhigherinflation. Secondly, any difference is to be identified and possible areas

ofimprovement for BB will be highlighted based on the empirical evidences provided from theanalysis of the functions of the RBA occuring over the period 1991 to 2008.

Bangladesh Bank Reforms:

BB was established under the Bangladesh Bank Order (1972) immediately after theindependence of the country in 1971, when it served mainly as a

department of thegovernment. Since then it has undergone major developments but the most significantchange came through when the government adopted the Financial Sector Reform Program(FSRP) in 1989. Results of the FSRP was a change, in 1990, to an indirect monetarymanagement from a rather direct intervention which was in practice back then. More recentdevelopments include those stipulated by the Bangladesh Bank Amendment Act which cameinto enforcement from 2003. This Act reduced the term of the governor of BB to a periodof four years from five years and mandated the appointment of four directors, who are not

government officials, as the bank’s central management board. Also, importance was givento functions such as domestic price level stability and introduction of a floating exchangerate system. A co-ordination council was also formed to facilitate balance of the centralbank’s policies with those of the government. A list of panoramic objectives with regard tothe interest of Bangladesh’s welfare in various aspects were also specified in this Act.Another ground breaking implementation for development of the BB was the Central BankStrengthening Project (CBSP) in 2003. Success of CBSP includes the establishment of aPolicy Analysis Unit (PAU) in July 2005 to increase the research and policy analysis capacityof BB. From January 2006, BB has been publishing half yearly monetary policy statements aswell as their research papers to promote transparency since those explain their monetarypolicy strategy and implementation tools.

The Reserve Bank of Australia Reforms:

The RBA has undergone many changes since the time of its inception in the year 1959under the Reserve Bank Act. It was initially operated by the central banking

division of thegovernment owned Commonwealth Bank of Australia and had set objectives such ascurrency stability, full employment and economic proseperity and welfare of the the citizensof Australia. Since 1959, the RBA enjoyed indepence to some level but amendments in thethe 1980s and 1990s further strengthed its position. These included several reforms occuringover the years such as the responsibility of public debt management being lifted off RBA in1986, official announcement of price stability to be an objective of the RBA in

1993,agreement between the governor and the treasurer acknowledging RBA’s independence in1996, introduction of publicationof quarterly monthly monetary policy instruments

highlighting its perception of the economy and its course of action and the newly formedAustralian Prudential Regulatory Authority (APRA) being delegated the responsibility ofsupervision and regulation of commercial banks in 1998. The independence and governancefostered faster after the government signed the statement on the conduct of monetary policywith the RBA in 2007. This increased the statutory independece of the governor and deputygovernor to that of the Comissioner of Taxes and stated that their appointment was to beconducted by the Governor-General in Council and can only be terminated upon approvalof each House of the Parliament in the same session of the Parliament. Previously these

were done by the government alone. From the 6th of November 2007, the RBA has started

publishing its board meeting’s minutes and later since February 2008, it published cash rateannouncements and short statements explaining bank’s decisions even if interest rates didn’tchange.

Frameworks of Reserve Bank of Australia’s Reform:

The fact that the RBA has enjoyed indepence to such a great extent has also given rise toextra responsibilities amongst which is greater accountability. The RBA has

been verysuccessful in this respect. The bank has developed a framework of its own which ensures itsindependence and proper execution and is mainly based on four aspects as oulined below –1) Multiple objectives – The central bank often has to deal with the trade off

betweeninflation and unemployment. It is generally known that these trade-offs don’t occurin the long run and by long term, a period of five years or mone is referred to.However, in the short run these trade offs do take place and it is up to the discretionof the central bank to take decision at times, say for example, when inflation goes offthe track. Decisions have to be taken to bring inflation back to its normal levelconstituting a real trade off with employment. Central banks can thus perform betterif their objective is not only to control inflation but other aspects of the economy aswell. During the second half of 1994 when there was an expectation of the interestrate to rise above 2-3 percent at a certain period, the central bank resorted to a fairlystrict monetary policy to limit the rise in inflation and the period over which it wouldoccur. It was argued that such course of action benefitted Australia from the loss itcould have incurred by following a more stringent monetary policy – in terms of lostjobs and output. This shows the multiple objectives of the RBA where it focuses notonly on reducing inflation but measures the weight of its actions on other aspects ofthe economy as well – such as employment, output and so on.

2) A flexible inflation target – Inflation target can be deemed to be an anchor for inflationexpectations and a way to make the monetary policies more deciplined. However attimes of dire need a flexibility helps the central bank to perform better. The RBA hasa target of maintaing 2 – 3 percencent inflation but this rate is flexible. It is alsoconsistent with the multiple approach concept since inflation has a cyclical effect on

employment and output – policies are allowed for only if their benefits outweight thecosts of lost employment and output.

3) Consultations between the Bank and the Treasurer – The Reserve Bank Act mandates sucha provision and this has been exercised in the RBA over the years which yieldedfruitful results. In this process both the governement and the central bank are awareof the same facts – implying that both tell the same story. Also, central banks need tobe informed about the economic activities elsewhere, such as fiscal policies, as itdeals mainly with monetary policies. All these policies are connected and it is a goodidea to devise policies which benefit all the aspects of economy. At times of

disagreement, the Treasurer’s view shall stand but he has to present both the Board’sview and his arguments for overriding those views to both Houses of Parliament.4) A Good Board – A very important part of the framework is that the decision makingauthority of the RBA should repesent a ‘real world’ dimension when considering thepolicy options. The Board has the delegatory authority to take any decision on behalfof the RBA including those with regard to lowering interest rates. The Board followsa proper hierarchy where only the Chairman is allowed to speak on behalf of theBoard and the rest comprises of decent, competent people who take their job quiteseriously as evidence suggests.

Data Comparison:

In the following, a comparison of CBIG index between the two central banks’ will behighlighted. As one can observe, the RBA has been able to maintain a

higher overall CGIBindex whereas BB struggled. However, recently, the index score improved.

Graph # 2: Comparison of CBIG Index of Australia and Bangladesh

Graph # 3: CBIG Index Score (1991 - 2008) – Australia

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Graph # 4: CBIG Index Score (1991 – 2008) - Bangladesh

It can be observed that Bangladesh’s legal index to be constant at 0.32 till 2003, butdropped to 0.28 when the term of the governor of BB was reduced to four

years from fiveyears. However, the legal index of Australia increased to 0.67 in 2008 after being constantfor a period of 10 years (1998-2007) at 0.6. A possible reason for this might be that the termof the governor has been increased to a period of 7 years. When the governor’s term is morethan that of the elected government, it leads to less influence by the politicians. Although thelegal power to appoint the governor is same in both the countries, the recent change inAustralian dismissal process keeps the standard of the RBA better than BB. The RBA wasfreed from the responsibility of regulation and supervision of the commercial banks but theBB was not. All these lead to a lower legal index score of BB.

The political CBIG Index started off at 0.89 in 1991 but came down to 0.56 in 1996 and2001because of the government’s efforts to try to change the governor of BB

during thesetimes. However, the index improved after the BB charter was changed in 2003. Reason whyBB scored poor than the RBA is that there was hardly any political influence in RBA but BBhad to consult the Ministry of Finance for every important decision. The turnover rate inBangladesh was strongly linked to changes in government and its representation in BB is

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1997

1998

1999

2000

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2002

2003

2004

2005

2006

2007

2008

CBIGIndexScore

Year

CBIG(Leg)

CBIG(Pol)

CBIG(Pstab)

CBIG(Frx)

CBIG(MonoPol)

CBIG(Acctrns)

also higher than the RBA. However, the 2003 BB amendment act aims to put an end to thisproblem.

The RBA scores a perfect Price Stability Objective Index of 1.00 and one of the mainreasons of it is that it had always considered price stability to be one of its

objectives.Inflation targeting and interest rate forecasting are considered to be vital macroeconomictools in Australia. BB strived to implement the inflation targeting system with the help of thegovernment but no provisions about it were mentioned in the legislation. It was not until2003that price stability was included in BB’s charter and the highest score

marked was 0.56.

The exchange rate policy index of BB used to be zero until the currency was floated in2003achieving the highest score of 0.33. However, the government retains some

right andonly entitles BB to little power over the exchange rate policies. In contrast, the RBA hasbeen responsible for the exchange rate policies in Australia ever since the currency wasfloated in 1983. Their immense success in this aspect of intervening and stabilizing exchangerate movement lead to a relatively higher score of 0.67.

Prior to 2003 the monetary policy and deficit financing index of the BB was only 0.22since it had to follow direct orders from the Ministry of Finance –

implying a very lowoperational independence. Later a Coordination Council was established of which theMinistry of Finance is the Chairand the BB governoris a memberto facilitate

communication. In contrast, the RBA marks a high score of 0.83 since 1991 implying that ithas been independently handling the monetary policy and deficit financing independence.One of the main reasons for this is that the RBA does not provide money to thegovernment and is in charge of the overall monetary policy.

The accountability and transparency index of BB has gradually increased from 0.17 in2002to 0.39 in 2003 and finally to 0.72 in 2006. Improvements as such occurred

primarilyfor the amendment act in 2003 which identified accountability as one of its objectivesincreasing the governor’s accountability to the parliament. Also the regular monetary reportswhich have been published since 2006 have contributed to increasing accountability. The

ge25

RBA’s scores in this aspect have been 0.86 till 2006 and increasing to 0.95 in 2007 for theboard meeting’s minutes it publishes.

Graph # 5: Comparison of Inflation of Australia and Bangladesh

Graph # 6: Comparison of GDP per capita of Australia and Bangladesh

From the graphs above, we can see that Australia’s GDP Per capita is far higher thanthat of Bangladesh and it has also been successful in maintaining an

inflation rate lower thanBangladesh. We analyze the data and interpret the graph in the later sections of the paper.What we are to look at in this segment is whether the high GDP per capita and low inflationrate of Australia leads to a higher CBIG Index. In other words, the relationship betweenhigh GDP and low inflation with CBIG is to be highlighted.

Recent Trends and Observations:

Even though the CBIG and GMT index scores are poor and the amount of governmentborrowing from BB has been increasing after 2002, the overall CBIG index

score ofBangladesh improved than previous. It can be said that even though Bangladesh Bank is notas autonomous as the RBA, but it has gained more independence over the years. But thequestion now remains whether BB’s autonomy affects the overall scenario in Bangladesh. Ifwe can find that along with poor autonomy the economy and development is curbed, we cansay that central bank’s autonomy is essential. However, if the results are seen that despite ofpoor autonomy, the overall indicators of development are well in Bangladesh, an alternativeconclusion can derive.

Some Positive Trends

Graph # 7: Discount Rate of Bangladesh Bank

Source: International Monetary Fund, 2009

Here we can observe that Bangladesh Bank has been able to maintain steady discountrate throughout. There has not been any high fluctuation. After 2003, the

discount rate hasbeen 5 %, which is lower than the call money rate (9% or higher). This shows that BB isencouraging people to borrow money, which probably has a positive influence in ourinvestment and output.

Graph # 8: Gross Domestic Product (Current Prices)


We can see that in terms of nominal rates, the GDP of Bangladesh has been increasingthroughout the years. Till about 2000, this growth was quite gradual,

however, after that, thegrowth has been exponentially high. This contributes positively to our economy and also tohelp improve our lifestyle.

Graph # 9: Poverty Headcount Ratio

Source: World Bank, 2007

Graph # 10: Human Development Index


In Graph # 9 and 10 we can observe that along with the annual GDP increase, the totalpoverty rate is decreasing and at the same time, the livelihoods of

Bangladeshi people areimproving. So despite of poor autonomy, the people in general seem to be doing well.However, there are obviously some areas for improvements which the following graphswould depict.

Some Negative Trends

Graph # 11: Employment in Bangladesh


Table # 5: Corruption Perception Index – Bangladesh Ranked 134

Source: Transparency International, 2010

In the above graph and chart we can see that in terms of employment, the currentpercentage of formal employment is decreasing. This could be caused by

various factors (ie,increase in the informal sector, decrease of child labour, etc). As one of the visions of BB isto help generate employment in Bangladesh, we can see that there is no real contribution andneither is there any initiative to do so. However, the primary cause for this is probablycorruption. For two years running (2008 and 2009), Bangladesh has been ranked as one ofthe most corrupted countries in the world by Transparency International (score of 2.4 out of10 in both years – the lower the value, the more corrupt a country). The

autonomy of thecentral bank will in no country assure the decline of corruption; however, the corruptiondoes have an effect on efficiency.

Inflation in Bangladesh

One of the biggest duties of BB is to maintain a stable inflation rate. As a smallpopulation of Bangladeshis are privileged, the price level plays a vital role.

If things becomeexpensive, for few people it would not make much difference, but for most, it would getvery difficult to function properly. The following graph shows the inflation rate (averageconsumer prices) of Bangladesh in various years:

Graph # 12: Inflation Rate in Bangladesh


Here we can see that before 1990, the inflation rate in Bangladesh was very high. Afterthe Financial Sector Reform Program in 1989 (mentioned in the previous

sections), theinflation rate drastically fell. For about 10 years, it was low; however, there were years wherethe rate peaked to very high levels (1995 and 1998). The reason for this is not poor monetarypolicy, but natural disasters (a high percentage of our GDP is contributed by the agriculturalsector). The BB was successfully able to restore the price level to a lower rate the followingyear, indicating good monetary policy makings. Moreover, the global financial crisis of 2008did not have any immediate effect on Bangladesh because the governor of BB (during thatperiod) Dr. Salehuddin Ahmed was able to analyze, understand the situation, and tookprecautionary measures (as discussed in a seminar by him at BRAC University).

It is also seen that after 2000, the inflation rate has been increasing, and continues to.Even though the price level did increase, the change was more gradual and

it was easier forpeople to cope up, instead of just suddenly having high prices the next morning (regardlessto say high price levels is not good for the poor people of Bangladesh). It must be kept inmind as well that most of the inflation that took place in Bangladesh recently was due to

cost-push inflation, not necessarily poor monetary policies. BB has been able to keep up anacceptable inflation rate, but this time, compared to previous data, the change/increase ismore gradual and adaptive.

Conclusion and Policy Recommendation

In written constitutions, Bangladesh Bank is autonomous, however in theory it is seenthat Bangladesh Bank’s independence is limited. But the question remains

whether centralbank’s autonomy is necessary for Bangladesh at this stage. We can see that despite poorscores in the GMT index and CBIG index, Bangladesh Bank has been performing quite well.The growth in our GDP, poverty reduction, and improvement in the human developmentindex all tends to show that the management board of Bangladesh Bank is not completelycontrolled by the government, but then again, the poor condition of employment and theinflation rate is growing every year beyond 5-6 % which indicates that there are still roomsfor improvement.

Bangladesh today is a developing country and most likely that is the prime cause of thispoor autonomy. However, we gave seen that the practical benefits of

autonomy is vast. IfBangladesh wishes to be a developed country in the future, a strong financial sector andprice stability is needed, for which the autonomy of the central bank is beneficial. Theholistic development of our country will only be ensured if we can help curb downcorruption, improve education, provide more chances of employment, etc.

References:

Arnone M., B.J. Lauren, J-F. Segalotto and M. Sommers, 2005. ‘Central Bank Autonomy,Monetary Frame Works and Exchange Rate Regimes,’ IMF working Paper

Ahmed, Haydory Akbar | Autonomy of Bangladesh Bank: Some Thoughts | Dhaka,Bangladesh: North South University, Young Economists' Forum; Conference

Proceedings of Prime Bank International Conference of Young Economists (ICYE)2007; pp. 9-15.

Ahmed AKN, 1997. Of Deregulation and Central Bank Autonomy. Dhaka: University PressLimited

Ahsan, A., Skully, M., & Wickramanayake, J. (2009). A Critical Analysis of Central BankIndependence and Governance in Australia and Bangladesh. JOAAG , 11-20.

Bangladesh Bank Order, 1972 (Presidents Order No. 127 of 1972) incorporating all amendmentsthere to up to March 10, 2003

Bangladesh Bank Annual Report 2004-05. Dhaka: Bangladesh Bank

Cukierman A., 1992. Central Bank Strategy, Credibility, and Independence: Theory andEvidence, Cambridge, Massachusetts: MIT Press

Data in Gapminder World. Gapminder. Date updated: November 2010. Date accessed: 23

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November 2010. < http://www.gapminder.org/data/>

Eijffinger, Sylvester C. W. and Jakob de Haan. 1996. The Political Economy of Central-Bank.Department of Economics, Princeton University, Princeton, New Jersey.

Fischer, S., 1995, Central Bank Independence Revisited. American Economic Review, Vol. 85,No. 2 pp. 201-206.

Grilli V., D. Masciandaro and G. Tabellini, 1991. Political and Monetary Institutions and PublicFinancial Policies in Industrial Countries, Economic Policy: A European Forum,

Vol. 6,October, pp. 342–391.

Lybek, T., 2004. ‘Central Bank Autonomy, Accountability, and Governance: ConceptualFramework,’ IMF, Write-up for Presentation at LEG 2004 Seminar August 18,

2004"Nonperforming asset." Investopedia. N.p., n.d. Web. 6 Dec. 2010.

<www.investopedia.com/terms/n/nonperformingasset.asp>.

Reserve Bank Independence. (1996). Reserve Bank of Australia Bulletin , 14-20.Walsh, Carl E. 2005. Central Bank Independence. University of California, Santa Cruz.

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