Sweden is known as the first country to have established the central bank, followed by England, France, Germany and others in North America, South America, Africa, Asia and in the Middle East. Originally, financing the war was the objective and later on, it was aimed at meeting the fiscal needs of the government. It was the politicians who created central banks and used to dictate those to follow government instructions.
The 18th century politicians allowed monopoly power to the central bank which would be both willing and able to offer cheaper credit to the government in return. The 19th century central banks were usually created by the politicians to serve fiscal needs of the government.
The 20th century central banks were established under political pressures as well as sometimes for governmental fiscal needs and sometimes for other particular reasons.
The main objectives of a central bank are:
1. Playing a critical role in economic management of all modern states: Many organisations have evolved to change the environment in such a way that now subserve the important goal. Some of them even have a vital role in modern economies. The central bank is one of such organisations that play a critical role in economic management of all modern states. Usually, central banks could not come into existence without government power behind them.
Both theory and experience show that there might be strong incentives for the government to abuse the central bank. That is why there is strong pressure to make some potential organisations like central bank independent of the government. In reality, it is the politicians who created central bank to serve the fiscal needs of the government. Kane (1980) said about the US Federal Reserve System: "After all, the Fed is a political institution designed by the politicians to serve the politicians."
2. Politicians created central bank to obtain credit on favourable terms: Historical evidence shows that the politicians in the 18th and the 19th century created central banks to obtain credit at favourable terms. The obvious way to get credit on favourable terms was done by giving central banks some privileges or monopoly power. Such a bank would be willing and able to offer cheaper credit to the government in return. The central bank had no inherent goal; its goals were decided by the government. But the same did not hold for its managers. The central bankers were the agents of the government and of the public but poorly constrained ones. It is pertinent to see central bank and its governor shifting from anticipation of political independence towards notions of the central bank as a part of the politically controlled bureaucracy and the governor as a loyal civil servant.
3. Governors and Deputy Governors are usually appointed by the government. In Europe, for example, the Bank of England, from its earliest days, could appoint and nominate its own personnel. The Governor, the Deputy Governors and directors were chosen every year between March and April (Elgie and Thompson 1998, p.36).
Independence was guaranteed because the Committee of the Treasury was created comprising the Governor, the Deputy Governor and the senior most directors with responsibility of preparing proposals for election of Governors and Directors. For 1931, a lower score on the overall index of independence was recorded because the degree of economic independence of the bank fell as result of its responsibility for selecting instruments of monetary policy being withdrawn. An attempt to measure the political independence of the Bank of England was made using Grilli, Masciandro and Tabellini (1991).
4. Central bankers enjoy privilege from the government. The central bank enjoys special rights and privileges that allow them to conduct monetary policy and objectives and to work as agent of the government. Periodic comparison of the role of central bank was indicated in the Victorian era beginning from 1840 to 1914. The governments tended to run surpluses in peace-time years and deficits were generally functions of war. Decades of government control was observed during 1930 until end of 1960s. During this period, politicians dictated the monetary policy in the central bank.
During the triumph of markets from 1980 to 2007, the central bank's independence got prominence, including mandated capital requirement, risk management, corporate governance and reduction of government intervention.
After World War II, spread of socialism resulted in the nationalisation of central banks excepting the Federal Reserve Bank of the USA and the roles of central banks were changed and these remained under control of the government.
5. Bureaucratic behaviour of central bank. First of all, a central bank seeks to keep its operations secret. It usually resists offering information about its actions. Such secrecy not only raises the prestige of the bank, but also protects it against criticism (Friedman, 1982, and Acheson-Chant, 1972, 1973, 1973). Second, for the same reasons, a central bank usually opposes any iron-clad rules and sticks to incomplete discretionary policies, and complex instrument-mixes, because it further lowers the ability of outsiders to monitor the actions of the bank-and thus to criticise it for a poor performance. Third, the theory predicts that a central bank will struggle for its independence. If a bank is independent and its responsibility for the monetary policy is not shared with other agencies, its prestige is ceteris paribus higher. Â
6. Central banks are given explicit macro-prudential mandate. This extends to both crisis prevention and crisis management and implementation of price stability-oriented monetary policy conducting micro-prudential supervision. The central bank plays its role in post-crisis period during which its independence becomes risky. Historical data reveal that during crisis time, index on central bank independence fell with exception of the US Federal reserve bank during 1694-1998 period.
7. Nationalisation and central bank independence. Evidences show that almost all of the central banks in Europe and Asia-Pacific region were nationalised between 1936 and 1950s including the Reserve Bank of India. There was a study on the central bank's independence indexes during 1694 - 1998 period. Findings of the study revealed that the Bank of England index of independence was 6 in 1694 which was reduced to 5 in 1931, further reduced to 1 in 1946 -1992 period and in 1998, it increased to 3. The index of independence of the Bank of France was 5 in 1800, 4 in 1808, 2 in 1945, 2 in 1992 and 5 in 1993. The independence index of German German Bundesbank was 7 in 1880 with very minimal or no independence during 1939 and again it dropped to 5 in 1997 which is considered as the best index of independence since the World War II. The independence index of the Federal Reserve Bank marked 2 in 1913 and 1939; it was 3 and in 1997, the index was 5. This shows a signal of greater independence of central bank when transition takes place in economic management from command, mixed and market system.
The nineteenth and early 20th century central banks had considerably more independence than they currently possess. During the mid-1940s and mid-1970s, the government became increasingly active in managing the economies and links between central banks and governments in the conduct of macro-policy became much closer. In post 1970s, the revival of independence and policy of granting greater independence to central banks became popular with greater autonomy.
8. Shift in central bank mandates. Mandates of central banks on interest rates and credit combination were shifted from time to time. Carment, Rainhart and Rogoff (2013) submitted evidence on the 100th anniversary of the Federal Reserve Bank of the USA for 91 years from 1921 to 2012. It reveals that the Fed for 8 years followed unambiguous easing with declining interest rate and accelerated credit growth and for 25 years it followed mixed easing with declining interest rates and unchanged decelerating credit growth. For 12 years, it continued with neutral to easing following unchanged interest rates and accelerated credit growth and 2 years neutral with unchanged interest rates and credit growth. Neutral to tighter policy continued for 11 years with unchanged interest rates and decelerating credit growth. Mixed tightening with rising interest rate and unchanged/accelerating credit growth existed for 21 years and unambiguous tightening prevailed with rising interest rates and decelerating credit growth prevailed for 13 years. Â
9. From secrecy to open communication. The central bank communication policy has changed from secrecy to increased openness with which central bankers spoke in public about policy decisions that they made and that they are likely to make in the future. Shifting toward greater transparency and more active communication about policy decision and intentions were not merely in passing but a fundamental change with important consequences for success with which monetary policy can be used to maintain economic stability. Â
Central banking is not like steering an oil tanker or even guiding a spacecraft and following a trajectory that depends on constantly changing factors. There was an expectation that the central bankers should seek to influence the rate of inflation over next several years. Forecast targeting as a policy framework for shaping expectations of market participants through central bank communication requires more than a mere willingness of the central bank to be forthcoming about its thoughts.
Jamaluddin Ahmed, PhD, FCA, is the Director of Emerging Credit Rating Ltd and Vice-President, the Bangladesh Economic Association.
 jamal@emergingrating.com