Central Bank is the fundamental body in charge of the monetary policy in a country which plays an important role in regulatory and finance systems. Its decisions are directly affected to country's inflation, interest rates, exchange rates, money supply and the economy as a whole. Central banks pursue a goal of maintaining an efficient and stable monetary and financial framework as its contribution towards a healthy economy (www.bankofengland.co.uk). Authors describe central banks as "the lender of last resort which means when commercial banks in difficult situations in funding, central bank is the final resource to rescue them. In another way, central banks provide the stability for country's financial systems. It could recently be seen in some countries. i:e: Bailed out of Northern Rock in UK.
Central Banks transparency and independence has become one of the major issues in Central Banks monetary policy recently. "Transparency is a broad term and it is quality of being clear and transparent or something can be seen through. The term of Central Bank transparency means the public can analyse Central Bank's decisions, inefficiencies, and documents. In economics, transparency is presenting symmetric information. (Petra M Geraats, "Central Bank Transparency, the Economic Journal, 2002)
"You are not here to tell me what to do. You are here to tell me why I have done, what I have already decided to do The economic adviser has believe to be told by the Bank of England longest served Governor (1920-44); (The Economist; Coming in from the cold; 1999). Traditionally Central Banks were mysterious and secret, and how much a Central bank shared with public? But comparing to traditional Central Bank, it's being changed to transparency and accountability.
According to the survey of transparency in 1998 of 94 central banks by Fry et. al. (2000), it has revealed that 74% of Central Banks concern, transparency is an important element in monetary policy (Petra M Geraats; the Economic Journal, "Central Bank Transparency, 2002).
Recently many Central banks became transparent by explaining the reasons for their decisions, forecasting inflation reports and so on (Maria and Andrew; "Central Bank transparency in theory and practice;2003). Federal Bank of US, Bank of England, Central Banks of Sweden, New Zealand and Canada are well known examples for increasing transparency.
However, Central Bank Transparency can be distinguished for five sections. They are Political transparency, Economic transparency, procedural transparency, policy transparency and operational transparency (Gerrats;2000).
REVIEW OF LITERATURE
WHAT IS TRANSPARENCY?
In economics, "transparency is presenting symmetric information. (Petra M Geraats, "Central Bank Transparency, the Economic Journal, 2002). Therefore Petra described that lack of transparency exists asymmetry of information and uncertainty. At the same time Petra suggested that transparency does not provide a complete certainty and accurate information. However, a structure of an Economy in a country is unpredictable for both Central Bank and Private sector, but transparency can be controlled as long as they have same information and the knowledge. According to the above definition for transparency, even though relevant information is available for public and if the information is not adequate, transparency does not exist (Petra M Geraats; the economic journal, "Central Bank Transparency).
"Transparency is simply means central bank and the public have the access to the same information when it's making economic decisions (Marc Tomljanovich; Does Central bank Transparency Impact the Market?; Southern Economic Journal 2007). Marc also defined it broadly, "since the central bank generally has access to the information, it needs to be passed accurately to the public. Accurate is difficult to define and most of the economist believe that more information is better.
At the same time Marc suggests of shifting to transparency as a time consuming process and a process of need an expertise as disadvantages.
TRANSPARENCY, MONITORY POLICY AND INDEPENDENCE
Central Banks transparency and independence has become one of the major issues in Central Banks monetary policy recently.
According to Blinder (1998) "Greater transparency in monetary policy increases the efficiency of the market and fairly affected to the private sector, because it helps to make better informed decisions. Therefore most of the economists agreed the greater transparency in monetary policy is attractive (Maria and Andrew; "Central Bank Transparency in Theory and Practice; 2003) while others argue partial transparency is also important to an economy (Jenson 2000).
Adam S. Posen of Institute of International Economics argued in his article of "Six Practical Views of Central bank Transparency; there are two main tricky allegations to observe in Central Bank transparency. That's the separation of transparency and independence of Central Banks. Increased transparency prevents Central Bank independence and secondly transparency provides sufficient responsibility for Central Banks in society. However, Adam's argument is to remove the objective of independence from Central Bank and adapt to a goal of increasing transparency and accountability towards society. Adam suggest that it makes Central Banks more flexible to respond the economic shocks by gaining trust among the public. At the same time he suggested that it should be applied for the Central Banks such as Bank of Japan, Federal Reserve in US and The European Central Bank.
Eijffinger and Geraats (2002) argued that transparency has many dimensions. As a result of many commentators approach different conclusions, Kuttner and Posen (1999) argued that transparency will enhance Central Banks to use unrestricted policies while Svensson and Faust (2002) conclude the opposite. (Andrew Hughes Hallett; Imperfect transparency and the strategic use of information;2003). Both of the authors argued that transparency reduce the inaccuracy in the private sector's decision making.
Dotsey (1987) and Rudin (1988), both argue that transparency leads increasing volatility of financial markets as a result of clearer more frequent information. Dotsey and Rudin argue, clear and more frequent information will cause asset prices to fluctuate more frequently and it cause unconditional volatility (Marc Tomljanovich; Does Central bank Transparency Impact the Market?; Southern Economic Journal 2007).
Binder et al. (2001), Poole, Rasche and Thornton (2002), and Chortareas, Stasavage and Sterne (2002), argue that the "transparency helps both monitory policy credibility among public and transfer clearer information to financial markets (Marc Tomljanovich; Does Central bank Transparency Impact the Market?; Southern Economic Journal 2007)
Tabellini's (1987) suggest that "central bank openness, removes that extra source of uncertainty helping the smooth functioning of fianancial markets.
Winkler (2000), argues that the central banks face an distinctive trade off between honesty, clarity and information efficiency. Any two of them can be achieved, but not all three (Marc Tomljanovich; Does Central bank Transparency Impact the Market?; Southern Economic Journal 2007).
It is essential to discuss the importance of transparency in Central banks and determine how lack of transparency affects on monetary policy and the impact on economy. According to the literature review most of the authors argue that transparency reduces the inflation and gives the central bank a great flexibility towards economic issues.
Transparency means central bank and public have access for same information in economic decisions. However there's an argument about information. It's essential to consider, the accuracy and clarity of information. Accuracy cannot be measured and defined in practice. However many authors argue about the accuracy and clarity should be qualitative and quantitative in the process of economic policy implementation by central banks (Marc Tomljanovich; Does Central bank Transparency Impact the Market; Southern Economic Journal 2007).
In practice most Central Banks increase the Transparency recent years. The prominent examples are Bank of England, Federal Reserve in US and Central Bank of Canada, New Zealand and Sweden.
According to The Economist magazine, Bank of England is popularly regarded as a highly transparent Central Bank. The interest rate decisions are taken by the monetary policy committee and it contains of four economists and five officials. The Minutes of the meeting is published within two weeks and it contains the current interest rates the reasons for changing the interest rates and how many members were voted. The inflation report is also published quarterly and it contains the inflation forecast towards the target rate simultaneously. The Federal Reserve of US and the Bank of Japan is also treated as highly transparent Central Banks which become more transparent recently. (The Economist, Coming in from the cold; 2009)
However the European Central bank remains implementing transparency to the same degree.
According to the argument as described in the review of literature, Binder et al. (2001), Poole, Rasche and Thornton (2002), and Chortareas, Stasavage and Sterne (2002), that "transparency helps both monitory policy credibility among public and transfer clearer information to financial markets. It's essential to analyse the reactions of financial markets as a result of reduction of information asymmetries between the public and central banks, towards its transparency. There is a classic example for transferring asymmetric of information. In 2003, during the Economic downturn due to publicly declared proposal to help lower long term market interest rates by Federal Reserve US had been given negative results. It's been concluded that the corresponding volatility in bond markets would have been avoided under a system of reduced openness. This issue has been considered by Fed officials in September 2003 and determined, while the central bankers make occasional public errors, whether it's worth the increase in public information gained through transparency. Then they had to discuss the importance of effective communication with public. However the Fed Reserve's monetary policy was named as "a veil of secrecy by most of the economics and media.(Marc Tomljanovich; Does Central bank Transparency Impact the Market?; Southern Economic Journal 2007).
At the same time it's essential to analyse the reactions of financial markets as a result of moving towards more openness of central banks. According to seven central banks' websites which were shifted towards more openness disclosure, during 1990, were focused by Marc Tomljanovich in his article "Does Central bank Transparency Impact the Market? (Southern Economic Journal 2007), it's found all the countries except Germany, the forecasting error has reduced for interest rates on the respective government bonds for most maturity lengths and the expectations theory has achieved better at the short term. This affect was slightly stronger for the banks that shifted to greater disclosure than the banks that who remain. At the same time conditional and unconditional volatility reduced for both groups. This result was consistent with Tabellini's (1987) view that central banks reduce an extra source of uncertainty by increasing greater disclosure of information.
However, when central banks' shifting towards transparency it's essential to consider honesty, clarity and efficiency of information. According to Winkler (2000) the above three cannot be achieved together while two of them can do. Central banks can publish whatever their decisions to the public, by the term of honesty and they can provide clear information such as inflation, exchange rates, and they have to give up internal information simultaneously. The second scenario is, central banks can provide clear information based on their internal decisions efficiently, and have to give up honesty. Finally central banks can focus on informational efficiency, avoid passing information to the public. Recently the political influence became a large issue among public, therefore central banks had to move away from the second alternative and the choice of clarity and informational efficiency was significant.
Moving to greater transparency, it's influenced financial market factors rather than microeconomic factors (Chortareas, Stasavage, Sterne; 2002 and Cecchetti, Krause; 2002). Their view can be determined by focusing on short term interest rates. Short term interest rates are affected to public expectations, which mean Short term interest rates are directly influenced aggregate demand of the economy.
As already mentioned in the previous sections, Central Banks have being departed from their mystery and secrecy traditional reputation towards the modern environment of transparency and accountability.Why have become central banks increasingly transparent? There are two factors have been analysed according to the research. The first can be described as the increasing in transparency and its effectiveness to the monetary policy and secondly, the association between transparency and accountability towards society. It can also be said that central banks transparency has been very helpful in improving the effectiveness its monetary policy and enhancing the accountability itself.
However, the independence of a Central Bank is also crucial. As long as a central bank remains independent in a domestic society, transparency and accountability are vital.
However, Central Banks need to become more unclosed, but it's not absolutely transparent. The economic conditions can be changed overtime, although Central Banks cannot completely conclude the ever changing economy. However if something goes wrong, Central Banks should be clever enough to justify!
- Andrew Hughes Hallet "Imperfect Transparency and the Strategic use of Information
- Adam S. Posen; "Six practical views of Central Bank transparency; Institute of International Economics; 2002
- Maria Demertzis ; De Netherlandsche Bank and Andrew Hughes Hallet; Vanderbilt University and CEPR "Central Bank Transparency in Theory and Practice; May 6 2003
- Mark Tomljanovich "Does Central Bank Transparency Impact Financial Markets? A Cross-Country Econometric Analysis ; Southern Economic Journal 2007, 73(3), 791-813
- Petra M Geraats, "Central bank Transparency; The Economic Journal; 2002
- The Economist "Coming in from the cold; 00130613,09/25/99;vol352, Issue8138