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Fiscal domination of monetary policy to end – Dr. Indrajit Coomaraswamy

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Former CBSL Governor Dr. Indrajit Coomaraswamy
Former CBSL Governor Dr. Indrajit Coomaraswamy

Former Central Bank Governor Dr. Indrajit Coomaraswamy noted that fiscal domination of monetary policy was to end under the new Central Bank governance framework. This will result in a pivotal change to the economy as the Central Bank will be prevented from excessively accommodating government deficits at the cost of high inflation and nominal interest rates.

“What we have had is fiscal domination of monetary policy. Successive governments have had difficulty managing fiscal policy responsibly and sustainably. They relied on the Central Bank to bail them out,” said Coomaraswamy speaking on 18 March on the sidelines of an event. He added, “This was either through direct financing through the Central Bank or financial repression where the Central Bank kept interest rates low for the government to be able to borrow cheaply. All these things dislocate the economy and create disturbances.”

Under the new legal framework in the long run there is no complete autonomy for the Central Bank.

Dr. Coomaraswamy said, “The inflation target which is at the heart of the monetary policy framework is set jointly through consultation with the Finance Ministry.”

The inflation target is announced by the Minister of Finance by a gazette. Coomaraswamy added however that the Finance Ministry would have little power to meddle on a daily basis with how monetary policy is conducted.

He said, “One must find ways to create sufficient space for the Central Bank to do its work in a technically proficient way.”

Dr. Coomaraswamy reiterated that there was no ‘supersedence’ of the Central Bank over the political authority of the country. He however noted that once the inflation target is set then technical analysis can be done in the setting of monetary policy. As has happened internationally once fiscal overhang is limited there will be an exponential growth in credit available to the private sector. Under the new framework, Dr. Coomaraswamy said, “You won’t be crowding out the private sector.”

Dr. Coomaraswamy called for countercyclical policy interventions by the government if the economy expands too quickly or contracts too sharply from its growth cycles.

Dr. Coomaraswamy highlighted the weakening linkage between monetary aggregates and inflation.

He said, “As the relationship between monetary aggregates got much weaker, Central Banks have abandoned monetary policy by switching to using monetary aggregates as the base.”

In the recent past, the country has faced record inflation. He said, “Although inflation has been there all over the world, I am however not aware of any country that has had it at 85%.”

He noted that more technical analysis must be done to show the root causes of inflation adding, “We haven’t done the work to say a large part of it is due to monetary expansion and deficit financing.” TP

Monday, March 20, 2023 – 01:00

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