FISCAL

While monetary policy in its various forms was highly effective in pushing back against the
Great Recession, it takes both monetary and fiscal policy, working together, to generate a
robust recovery. In fact, when he was Federal Reserve chair, Ben Bernanke made precisely
this point in congressional testimony: Although monetary policy is working to promote a
more robust recovery, it cannot carry the entire burden of ensuring a speedier return to
economic health. The economy’s performance both over the near term and in the longer
run will depend importantly on the course of fiscal policy.
Second, monetary, and fiscal stimulus attack different parts of the problem in weak,
demand constrained economies. Monetary stimulus works largely through lowering the
cost of borrowing, but people hurt by high unemployment may have too little income to
take advantage of low interest rates. Relatedly, investors may see too little demand to take
on new projects. To the extent that fiscal stimulus puts money in people’s pockets, say
through infrastructure programs, direct job creation, temporary tax cuts, or increased
safety net benefits (e.g., ramped up unemployment insurance), low and middle-income
people themselves can be more likely to take advantage of low borrowing costs, or to signal
to investors through increased consumer demand that they should take advantage of low
rates. Third, monetary and fiscal policies interact in recessions to boost fiscal multipliers. If
the economy is operating at full employment and government spending generates a
positive fiscal impulse, CB may be likely to offset such spending by raising rates
The credibility of fiscal policy greatly influences the conduct and effectiveness of monetary
policy. Monetary policy is more effective when the private sector trusts that the
government will not resort to inflationary deficit financing. Therefore, central banks have
an incentive to monitor fiscal positions closely as: (1) the governments may be tempted to
call on central banks for debt financing, which would then directly damage the central
bank’s credibility; and (2) fiscal policy can have a significant impact on the economy as well
as the financial markets. Analysis of fiscal policy and public debt sustainability often hinges
on the expected path of public debt. Underlying the projected debt dynamics are factors
such as the ability of the government to raise revenues or limit expenditures, medium-term
growth prospects and market sentiment that may influence the cost and availability of
financing. Rising contingent liabilities, especially those that are less transparent and
implicit in nature, may result in a surprise public debt overshoot. The next section of this
country paper will offer a brief review of Thailand’s public debt development. The paper
will then highlight several concerns regarding fiscal policy and public debt, followed by
important implications for the central bank.

INTRODUCTION
Independence means that, except in exceptional circumstances, nobody can interfere in the
decisions made by the central bank in the exercise of its functions or, reverse the course of
its decisions (Patat, 2003). More precisely, CBI relates to three areas where the influence of
government must be either excluded or drastically curtailed (Hasse, 1990): organic,
functional, and financial independence.
Organic independence relates to the conditions of appointment of the central bank
executives, the term and the renewal of their mandates (in particular of the governor), as
well as the composition of the central bank’s governing bodies, i.e. if government
representatives have (or not) the right to sit and vote within these authorities. However,
Bassoni and Cartapanis (1995) underline that recent studies have focused on real term of
governors’ mandates (TOR) and, on the degree of synchronization between the mandates
of central bank governor and of chief of executive power.
Functional independence (or operational independence) refers to the effective freedom
which central bank has, not only in the definition of objectives to pursue, but also in the
conduct of monetary policy, that includes the choice of instruments. According to Henning
(1994), independence refers to the ability of the central bank to use the instruments of
monetary control without instruction, guidance or interference from the government. Thus,
some authors subdivide the functional independence and make a difference between: (i)
goal independence, (ii) target independence and (iii) instrument independence. The
difference between these three levels of independence is nevertheless subtle and so
requires to be clarified, especially the two first levels4 Goal independence imparts to the
central bank to determine the monetary policy and exchange rate regime, or simply the
monetary policy if it is a floating exchange rate. More precisely, goal independence gives to
the emission institute the authority to determine its primary objective among several
objectives included in the central bank law or, rarely to determine its primary objective if
the law doesn’t clearly define the objectives. (ii) Target independence, as the precedent
form of independence, entrusts the monetary authority with the responsibility of
determining the monetary policy and exchange rate regime, or simply the monetary policy
if the exchange rate is floating. However, target independence differs from goal
independence because the primary objective that the central bank must pursue through its
monetary policy is clearly defined in the law. So, the central bank has an absolute
autonomy in the choice of specific target (monetary base, interest rate, inflation rate) to
pursue its legislative objective(s), such as price stability.
iii) Instrument independence means that the government or the legislature defines the
monetary policy and its objectives, in accord with the central bank and the exchange rate
regime, but the monetary authority keeps sufficient autonomy to implement this policy
using the appropriate instruments. According to Debelle and Fischer (1994), a central bank
should have instrument independence but not goal independence (Grilli et al. [1991] call
these two dimensions “political independence” and respectively “economic
independence”). Indeed, goal independence is clearly the form of independence giving
greater autonomy to a central bank. But, Lybek (2004) and Blinder (1998) bring
interrogation to the justification to give the central bank such authority because governors,
who are not elected by citizens directly, should have the power to decide the short-term
trade-off between inflation and unemployment. On the contrary, we think that the fight
against inflation must be seen as an inestimable public good and not as the simple
counterpart of unemployment, particularly in developing economies where inflation affects
primarily poor and vulnerable populations.
Financial independence refers to the possibility (and to what extent) of a government to
finance its expenditures by resorting directly or indirectly to advances and loans from
central bank. Moreover, according to Bassoni and Cartapanis (1995) financial
independence allows the assessment of the budgetary “breathing space” which central
bank disposes, i.e. CBI vis-à - vis its financial resources necessary to its functioning. This
second aspect of financial independence can be described as budgetary independence. The
definition of CBI allows us to show the complexity and the pluri-dimensionality of this
concept and so, the difficulty to measure this independence.

INFLATION
When using a more appropriate estimator and model, taking into account the effects of lag
inflation on the dependent variable, a direct negative relationship between the
independence of the central bank and inflation, is not found in twenty countries in Asia, an
interesting fact in this empirical study. Then the next question is, why? This study has
found three things that cause the independence of the central bank have a positive effect on
the level of inflation in this study are: First, distortion from politicians can still influence
even though the central bank has independence. Second, central bank interdependence as
part of an institutional system does not allow the central bank to be independent. Third, de
jure independence is different from de facto independence. Thus, the independence of the
central bank is not enough. Other elements are needed to participate and strengthen the
independence of the central bank so that it is effective in suppressing the rate of inflation.
The interaction variables show a negative relationship with the level of inflation.
This result implements the banking intermediary function that must be continuously
improved, considering that the financial system in Asia still depends on the banking sector.
With an excellent intermediary function, the effectiveness of the monetary policy
transmission mechanism, primarily through the credit channel discussed in this study, is
getting better. Whereas institutional quality ensures that central bank transactions with
other institutions in the institutional system run well following existing contracts so that
distortions from politicians can eliminate. So, it is not to increase the independence of the
central bank as a solution to policy distortion, but to develop a system of supporting the
independence of the central bank is a solution. If the supporting system can develop central
bank independence is not only de jure but also de facto.
An independent Supreme Court Justice cannot be fired for rendering unpopular decisions.
The rationale for having an independent Supreme Court is a belief that majority rule may
sometimes produce undesirable outcomes. An independent Supreme Court limits the
power of transient majorities to alter certain fundamental rights of a nation and thus
contributes to its long–run stability. John Maynard Keynes wrote in 1924 that “...the
[Treasury and Bank of England] should adopt the stability of sterling prices as their
primary objective”. Across countries, there appears to be an inverse relation between
average inflation and the degree of central bank independence. It is noted that most
economists believe that monetary policy can have important effects on output and
employment only in the short-run; in the longer–run, the central bank can affect inflation
but not employment.
The history of money over the past two centuries shows nations groping for lasting
institutional structures that provide incentives to limit their own governments' temptation
to debase their currency to satisfy shortsighted political objectives. The approaches used in
the past have stemmed directly from both the nature of money prevailing at the time and
societies' views about the proper role of government. Nobel Prize winning economist
Hayek put it this way: “History is largely a history of inflation, and usually of inflations
engineered by governments and for the gain of governments.” What remains uncertain is
the mechanism that will prevent such history from repeating itself. More directly, the
challenge remains to devise a sustainable institutional monetary arrangement that can
protect the public from debasement of the value of its money. The fiat monetary standards,
that are not supported by convertibility into intrinsically valued commodities, such as gold
or silver, have created a widespread recognition that national monetary authorities should
not deliver price stability unless careful attention is given to the incentive structures under
which they operate. Consistent attempts to expand the economy beyond its potential for
production will result in higher inflation while ultimately failing to produce lower average
unemployment. In fact, extreme rates of inflation (or deflation) may so disrupt the role of
the price system in directing resources in a market economy that the result could be slower
average growth and higher average unemployment. Although economists continue to
debate whether reducing inflation from moderate to low rates would significantly improve
the long-run performance of the economy, most believe that there are no long-term gains
from consistently pursuing expansionary policies.
Inflation might affect potential output in a number of ways. First, inflation may interfere
with the efficiency of the price system and make it more difficult for households and firms
to make correct decisions, in response to market signals. It is often argued that when most
prices are rising, economic agents find it harder to distinguish between changes in relative
prices that require them to reallocate resources and changes in the overall price level that
require no such microeconomic response.
Second, inflation imposes various cost on the economy that would disappear if prices were
stable. The search costs imposed on buyers and sellers when prices change often, and the
costs of economizing on holdings of non-interest-bearing money are familiar examples of
the costs of changing prices. Inflation also has differing effects on individuals. For example,
the incomes of wage and salaried workers generally are adjusted for inflation only
annually, whereas self-employed workers can alter the prices of their services more
frequently. Similarly, inflation especially when it is unexpected tends to benefit borrowers
at the expense of lenders. In case of farmers, inflation benefits the net sellers while reduces
the real incomes of the net byers and thereby increases income inequality. Finally, because
some parts of the tax code are indexed for inflation whereas others are not, generalized
increases in prices have differing effects on individual taxpayers. As a result of these
considerations, inflation often is perceived as causing unfairness, since some households
and firms benefit, and others are harmed. However, whether these differential effects of
inflation are unfair, they do impose real costs on society at large. They frequently add to the
uncertainties that households and firms face, which may be undesirable even for those that
turn out to benefit. And many activities that seek to reduce the impact of inflation on
individuals may hurt the overall economy but yield no corresponding overall benefits. In an
inflationary economy, for example, talented persons may devote their energies to
developing strategies to avoid the deleterious consequences of inflation for themselves
rather than to inventing new products and processes that would raise overall living
standards. Unfortunately, many of these activities that aim to mitigate the effects of
inflation are counted as additions to measured GDP, even though they may not add to
welfare in any meaning sense. Finally, inflation may affect investors' saving and investment
decisions, reducing the proportion of GDP devoted to investment and causing the economy
to accumulate less productive capital. For example, when inflation is high, it usually tends
to be more variable and so harder to forecast. Uncertain inflation makes it more difficult to
deduce the real returns on investments from available market information. As a result,
savers and investors are less willing to enter long-term nominal contracts or to invest in
long-term projects. The reduced stock of productive capital the results from decreased
investment will, in turn, imply lower levels of future GDP. In practice, most central banks
care about both inflation and measures of the short-run cyclical performance of the
economy. However, pursuing multiple goals can create conflicts for policy; for example, the
desire to mitigate short-run downturns raises the issue of whether this goal should take
precedence over a low-inflation goal at any particular point in time.
Thus, it is important to avoid allowing short-run, temporary successes in preventing
employment losses during recessions from leading to longer-run failures in maintaining
low inflation.
Cukierman, Webb, and Neyapti's (1992) discussion of their evidence on the connection
between inflation and central bank independence has exposed an important issue: the role
of the exchange rate regime. But they took the matter no further. It has been demonstrated
here, using their data, that there were indeed significant differences in the 1980s in the
inflation performance of developing countries with different types of exchange rate
regimes. Moreover, those differences were associated with systematic differences in the
relation between inflation and Cukierman, Webb, and Neyapti's measures of central bank
independence. Specifically, it has been shown (as Cukierman, Webb, and Neyapti
anticipated) that for countries with pegged exchange rates (in Cukierman, Webb, and
Neyapti's terms, countries following an exchange rate rule), the connection between
central bank independence and the country's inflation performance was much weaker than
in countries where no such rule was in place. We also found that for countries whose
exchange rate regime had changed over the decade, the relation between central bank
independence and inflation was entirely perverse.
These findings raise several questions that merit further investigation. Among them are the
interrelated issues of causality—does it run from the choice of exchange rate regime to
inflation, or the other way around? —and credibility—is the simple choice of regime
sufficient? Future research on the core question of central bank independence may need to
be more sharply focused, because such independence seems likely to have very different
manifestations and to critically depend on the nature of the exchange rate regime with
which it is combined.
PRICE STABILITY
We use new yearly data on de jure central bank independence and examine whether CBI
has a greater effect on price stability when a country has institutional mechanisms that
limit political interference in central banks’ activities. Institutions such as checks, and
balances or freedom of the press differ significantly across political regimes and allow the
central bank to highlight and resist attempts by the government to influence it. This should
have two consequences. First, by limiting interference, these institutions allow a central
bank to be more disciplinarian, leading to lower rates of money growth. Second, if the
public believes that the central bank is free from interference and that the law is unlikely to
change swiftly and without debate, it will also lower inflationary expectations, leading to
price stability above and beyond the control of the money supply. We use different
estimation techniques, multiple operationalizations of the dependent variables, and many
controls to test the empirical implications. The results show strong support for our
argument.
Prompted by the IMF or the EU, but also driven by competition in international trade and
investment, countries have delegated monetary policy to independent bureaucrats. This
trend has caught on not just in countries with rule of law, a free press, and meaningful
opposition. Nondemocracies such as Venezuela, Kazakhstan, or Russia have also adopted
legislation giving their central banks nominal independence. Our results show that for such
countries, the central bank cannot be expected to discipline the government and have
lower rates of money growth. This finding is novel and important, given the imperfect
control that central banks have on inflation. Our results also strengthen and extend the
findings of the political economy literature. With new data and a research design reflecting
the sources of inflation, we show that the effect of CBI on inflation expectations is unlikely
to hold in nondemocratic countries. Additional research is needed to understand the
credibility effect of central banks, including careful examination of the costs of disinflation.
Moreover, as we noted, our results on either inflation or M2 changes are not driven by the
OECD sample, extending our knowledge beyond that of CBI’s effect on inflation in
developed countries.
Future work needs to better understand whether there are other benefits for
nondemocracies from de jure delegation to the central bank (such as access to credit and
foreign direct investment) or whether dictatorships enjoy political benefits from delegation
(that is, longer survival and less need to manipulate elections).
Our research has additional implications for democracies that have delegated monetary
policy only partially (Uruguay, South Africa, Mongolia, and South Korea). For such
countries further reform of the central bank law is likely to aid price stability with both a
discipline and a credibility effect.

Financial independence is the key element of central bank’s full independence. If confidentiality is
important for the success of monetary policy, central bank must be financially strong. Practical
implication of this premise means that a financially sound central bank should ensure that its strength is
sufficient to tackle all challenges and responsibilities in pursuing its policy and accompanying risks. To
be able to pursue its policy independently, a financially sound central bank
must have appropriate mechanisms and instruments to be used for attaining set objectives. Legal
independence in most of central banks worldwide trended up in the 1990s resulting from sizable
amendments to central bank laws during the last twenty years. The South-Eastern Europe countries
followed the same trend. This paper answers whether such legal independence contributed also to
strengthening the actual central banks’ independence, concluding that it does not depend
on their legal status only, but on many formal and informal institutional (and non-institutional)
arrangements related to budget management, defining the amount of reserves and capital, profit allocation
and covering of potential losses issues.
The paper stresses that the assessment of central bank’s position and independence particularly requires
the manner of defining the objectives under central bank’s responsibility, the freedom in selecting
instruments for their pursuing and strategies for their accomplishing. The independence indices measure
central bank’s independence, and they serve to assess central bank’s independence
and inflation, economic growth, and other macroeconomic variables ratio. The text refers to central
bank’s independence index survey relative to its budgetary independence, including the prohibition of
monetary financing, while methodology used for measuring independence index focuses on two primary
fields: prohibitions/limitations of direct credit to government and budget index. The
prohibitions/limitations of direct lending to government take into account two subcriteria: direct and
indirect credit limitations, while budgetary index includes five criteria: ownership of budget and capital;
budget/financial plan management; profit allocation; central bank’s residual profit allocations and
potential NCB loss coverage. The paper concludes that financial and budgetary independence of central
banks are highly correlated.
This paper indicates that the financial crisis altered the initial assumptions and positions referring to
central banks’ financial independence and that many non-standard monetary policy measures that have
been undertaken resulted in amended central banks’ balance sheets: total assets and liabilities increased,
while the risk substantially rose.
It particularly points that the structure of central bank’s balance sheet largely determines its risk profile,
and consequently the financial independence, thus the second part of the paper discusses the topic
referring to the fact that expansion of central bank’s balance sheet during a crisis has implications both to
the financial sector and the real economy. It assesses that the public-political focus becomes particularly
strong in the financial crisis periods, and that such expansion of central banks’ balance sheets has spread
the risk possibilities including possible inflation, financial instability, disorders at the financial market and
potential conflicts on public debt management. The third part of the paper implies that, when needed,
credible central bank must have available mechanisms to have sufficient capita and/or reserves to execute
all its tasks with the remark that central bank’s institutional aspect includes central bank’s capital, rules
for profit allocation and its effect on bank’s independence. This part touches the issues of importance and
role of capital in central bank’s balance sheet and its importance as a buffer in crisis period, as well as a
lever used for measuring central bank’s financial strength. The treatment of earned profit allocation, and
budget drafting and disposing are also instruments used by central banks to ensure and strengthen their
own financial strength and/or independence in executing own objectives and tasks. In general, it may be
concluded that central bank, as an institution, cannot solely select the optimal level of its financial
strength and analysis. To wit, determining central bank’s strength requires a detailed analysis not only of
central bank’s economic environment and balance sheet, its accounting standards, profit transfer rules and
the amount of its capital, but also of the institutional status of central bank in relation to the government.
Continuously cooperating with the government and the parliament and using proper and wise application
of instruments and mechanisms they manage; central banks will manage to ensure the attainment of their
tasks while preserving their independence in all aspects.