Sri Lanka govt gives nod to central bank independence
ECONOMYNEXT – Sri Lanka’s cabinet of ministers had given approval for legal changes to make the country’s central bank independent ahead of the country moving into a modified inflation targeting regime, the government said.
Sri Lanka’s central bank was built under US advice in 1950 to move the country in to a now-collapsed Bretton Woods dollar soft-peg system, and helped bring high inflation, draconian exchange controls, economic collapse and political instability which comes with high inflation and currency collapse.
The law had strong features of fiscal dominance of monetary policy, with the Treasury secretary being a member of the rate setting monetary board, who could veto attempts to raise interest rates when budget deficits went up and stop printing money.
Changes to laws governing the central bank and related laws were approved by the cabinet this week, the state information office said.
The central bank’s money printing ability helped politicians create chronic budget deficits removing a so-called ‘hard budget constraint’ that existed with the earlier monetary arrangement involving a currency board and a permanently fixed exchange rate.
The worst such controls took place in the 1970s when the Bretton Woods peg system also collapsed with an oil and commodity bubble amid US money printing and attempts to boost growth during on top of Vietnam war spending under then Fed Governor Arthur Burns, who was under the thumb of President Richard Nixon.
The money printing also triggered foreign exchange shortages, which in turn resulted in draconian exchange and trade controls, giving room for protectionists to claim falsely that trade deficits and imports caused balance of payments trouble rather than printing money and excessive credit.
Soft-pegs break due to a fundamental flaw of trying to control both interest rates and exchange rates. Before 1951 Sri Lanka did not print money to control rates and the interest rates floated.
Most developed countries now have floating exchange rates with controlled interest rates and a inflation targeting law to restrain money printing.
Sri Lanka’s central bank is planning a modified inflation targeting law, which has been cautiously welcomed by analysts, though with warnings that a central bank which collects forex reserves is still a peg. (Colombo/Apr06/2016)