Autonomous central banks

In recent days the thirtieth anniversary of the autonomy of the Bank of Mexico was celebrated. Indeed, on April 1, 1994, the law that granted autonomous status to the Mexican central bank came into force. This legal change was part of a wave of institutional reforms in Latin America in which various central banks in the region obtained their autonomy.

The country that began these reforms was Chile in 1989, followed in the nineties by El Salvador, Argentina, Colombia, Nicaragua, Venezuela, Ecuador, Peru, Mexico, Bolivia, Costa Rica, Uruguay, Paraguay and Honduras; and continued at the beginning of this century with reforms in Guatemala and the Dominican Republic. The only large country in the region that did not join this trend at that time was Brazil, whose central bank only obtained operational autonomy in 2021. In some cases, the respective law was modified to be able to adopt the dollar as legal tender. , as in the cases of Ecuador and El Salvador.

The explanation behind this wave of central bank autonomy in Latin America is the combination of two factors over time. On the one hand, the entire region had been emerging from a very turbulent decade, with very high inflation and episodes of devaluation and macroeconomic instability. This was, let us remember, the so-called lost decade of Latin America. During those years, at least three large countries in the region (Argentina, Brazil and Peru) went through episodes with inflation exceeding one thousand percent, while two other countries went through even worse situations called hyperinflationary (Bolivia and Nicaragua).

On the other hand, at the level of economic analysis, the importance of eliminating the inflationary bias of monetary policies and promoting autonomy in the management of central banks had begun to be raised. The theoretical contributions of economists such as Robert Barro, David Gordon, Alberto Alesina and Kenneth Rogoff, as well as the empirical evidence provided by Alberto Alesina and Larry Summers, among others, definitively contributed to justifying the search for greater independence of central banks. of political decisions.

Thus, the need to combat inflation throughout the region coexisted at one point in time along with the theoretical and empirical justification to do so through legal reform. This explains the reason for the wave of reforms to Latin American central banks at the end of the 20th century.

The results of these reforms are visible to all. Finally, most Latin American countries managed to control inflation through the autonomy of their central banks. With the exception of a few years and a few countries, the entire region is currently characterized by relative price stability. In 2024, for example, the vast majority of Latin American countries will have single-digit inflation and in almost all of these countries inflation will be less than 5%. The exceptions are Venezuela, Argentina and Haiti, which are three countries that have been struggling for decades to achieve a minimum of macroeconomic stability.

In order to quantitatively appreciate what the autonomy of central banks has represented for some countries in the region, it is enough to compare pre- and post-autonomy inflation. For example, in Chile, Colombia, Mexico and Peru, the average annual inflation between 1974 and 1990 was, respectively, 88%, 24%, 49% and 737%. So far this century, the average annual inflation in those same countries has been only 3.7%, 5.3%, 4.7% and 3.1%, respectively. The change is notable and the role of central bank autonomy cannot be minimized. It is evident that the macroeconomic stability that these countries have achieved has as one of its pillars the autonomy and independence in the management of their central institutes.

In those countries where autonomy has not been sufficient to achieve price stability, the explanation for their failure lies both in the absence of fiscal responsibility, and in the difference between de jure autonomy and de facto autonomy, that is, between what the law says and what really happens. In Argentina and Venezuela it is evident that the autonomy of the central banks has not been full and that it has deteriorated significantly in recent years. This deterioration has occurred through frequent interventions in the appointment of authorities (a greater turnover than provided for in the law) or through operational changes in the instruments used by central banks (allowing financing to the central government).

These examples, both positive and negative, reveal the importance of fully preserving the autonomy of central banks in the region. The control and dominance of inflation in Latin America has cost so much effort that it is something that we must try to preserve at all costs. Therefore, the autonomy of central banks in the region is welcome!

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