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CENTRAL BANK AND MONETARY POLICY. Mario A. García Lara Vice-President of the Banco de Guatemala. Origin of the Central Banks. Riksbank (Sweden, 1656) and Bank of England (1694) arise as state banks (debt management)

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CENTRAL BANK AND MONETARY POLICY

Mario A. García Lara

Vice-President of the Banco de Guatemala


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Origin of the Central Banks

  • Riksbank (Sweden, 1656) and Bank of England (1694) arise as state banks (debt management)

  • It is generalized as of the beginning of the XXc., before the need to have an only money issuer and reduce banking chaos during the era


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Origin of the Central Banks

  • The Federal Reserve System in the United States arises in 1914.

  • The Bank of Canada began operations in 1934 after the “ Great Depression”.

  • In 1914 there were 18 central banks. In 1950 there were 59, and 161 in 1999.

  • Their role as only issuers allowed them to regulate the MONETARY POLICY


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Monetary Policy: a component of the economic policy

ECONOMIC

POLICY

EFFICIENCY

POLICIES

MONETARY

POLICY

FISCAL

POLICy

INSTITU-

TIONAL

POLICY

=

+

+

+

DEREGULA-

RIZATION AND

OPENING

PROMOTE

EFFICIENCY

(SUPPLY)

MONETARY

OFFER AND

INTEREST RATE

INFLUENCE W/O

ADDED

DEMAND

EXPENSES AND

TAXES

INFLUENCE W/O

ADDED

SUPPLY AND

DEMAND

INSTITUTION

IMPROVEMENTS

“GAME RULE”

(SUPPLY)

INSTRUMENTS

INCREASE

THE

PRODUCT-

IVITY

PRESERVE

STABILITY

SUPPORT

STABILITY

AND PRO-

DUCTIVITY

MAKE

GROWTH

VIABLE AND

SUSTAINABLE

OBJECTIVES

GROWTH AND DEVELOPMENT



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Simplified Economic Policy

fiscal policy

monetary policy

The temporary tank only avoids a crisis temporarily, while the main problem is solved.

If the temporary tank overflows, an economic crisis of great proportion will ocurr

money

Inflation deficit devaluation

production


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Simplified Economic Policy

  • Macroeconomic Crisis: in almost all countries.

  • In Guatemala:

  • Inflation: 32% (‘85), 61% (‘90)

  • Ext. Deficit: 6.7% (‘81), 7.1 (‘92)

  • Devaluation: 45% (’90), 14% (’99)

  • Central banks are entrusted the responsibility of preserving stability in the general level of prices


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Recent Evolution of Central Banks

  • Technological Progress + economic integration + financial globalization  the traditional functions of central banks turn more complex and difficult.

  • Central banks can not pursue multiple objectives of economic policy (like they did two decades ago); now they are centered in a main objective: promote stability in the general level of prices.


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The role of the Banco de Guatemala in the Economy

  • A. Fundamental Objective

  • Following international standards, the Organic Law (article 3) establishes the objective of

    • “…contributing to the creation and maintenance of the most favorable conditions for orderly development of the national economy, for which, it will propitiate the monetary, exchange rate and credit conditions, that promote the stability in the general level of prices”.


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    INCREASE EFFECTIVITY OF THE MONETARY POLICY

    Orientation of the Organic Law (2002)

    STRENGTHEN AUTONOMY

    PROPITIATE MACROECONMIC

    STABILITY

    STRENGTHENCREDIBILITY

    CREDIBILITY + AUTONOMY = EFFECTIVITY  STABILITY


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    EFFECTIVITY =

    CREDIBILITY + AUTONOMY

    • III. ECONOMIC FINANCIAL AUTONOMY

    • treatment of the net deficiencies or net excess of the central bank maintenance of capital of the central bank on behalf of the State

    • zero credit to the government

    • clear definition of central bank-government relations

    • II. OPERATIVE

    • AUTONOMY

    • independence in the use instruments

    • overlap in the period of duration of the Directors regarding the Executive Power

    • destitution of Directors only for an established cause

    • IV. TRANSPA-RENCY and ACCOUNTS RENDITION

    • the monetary policy and its foundations must be made known to the public

    • the central bank must render accounts periodically before Congress

    • I.

    • CLARITY OF THE FUN- DAMENTALOBJECTIVE

    • eases the consecution of the objective

    • establishes a correct scheme of account rendition before society


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    1st. Pillar in the Organic Law

    CLARITY OF THE FUNDAMENTAL OBJECTIVE

    Article 4 establishes that the functions of the institution are exercised privileging the achievement of the mentioned objective

    Article 3 establishes that as its fundamental objective the Banco de Guatemala will promote the stability in the general level of prices

    Articles 26, 30, and 34 establish that the attributions of the Monetary Board, of the Presidency and the Management are exercised without undermining the achievement of the mentioned objective

    • Instruments are redefined in function of the objective:

    • Legal reserve (Arts. 43 to 45)

    • OMAs (Art. 46)

    • Exchange ops. (Art. 47)

    • PUI (Art. 48)


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    2nd. Pillar in the Organic Law

    OPERATIVE AUTONOMY

    Article 13 reaffirms the integration of the Monetary Board, according to article 132 of the Constitution, and article 14 declares that the members must act in function of national interest and of the fulfillment of the fundamental objective of the central bank.

    Article 26 reaffirms the constitutional power of the Board to determine the monetary policy, and article 40 delegates the Banco de Guatemala, as an autonomous entity, the capacity to execute said policy through an Execution Committee

    Articles 28 and 84 establish overlap in the duration of the charge of President and Vice-president of the Banco de Guatemala, regarding the presidential period of the Executive Organism

    Article 20 establishes the causal for which the President, Vice-president and the elected members of the Monetary Board can be removed.


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    3rd. Pillar in the Organic Law

    ECONOMIC AND FINANCIAL AUTONOMY

    • Patrimonial strengthening of the central bank.

      Article 83 foresees making the accumulated cost of monetary, exchange rate and credit policy

    • Credit to the government.

      Article 71 observes, among others, the prohibition to the central bank to grant credit to the government contained in article 133 of the Political Constitution of the Republic of Guatemala.

    • Maintenance of capital in the central bank.

      Articles 8 and 9 establish that the net deficiencies or excess derived of the execution of the monetary, exchange rate and credit policy will be absorbed by the State


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    4th. Pillar in the Organic Law

    TRANSPARENCY and ACCOUNT RENDITION

    Articles 63 and 64 establish that it is obligatory to publish the Board debates and the resolutions that correspond to the determination of the monetary, exchange rate and credit policy

    Article 61 establishes the publication of the monetary policy report with an explanation of the operations made to reach the fundamental objective

    Article 62 establishes that it is obligatory to report information and general publication of important data associated to the business of the central bank

    Article 34 literal i) establishes the publication of the Income and Expense Budget of theBanco de Guatemala


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    4th. Pillar in the Organic Law

    TRANSPARENCY and ACCOUNT RENDITION

    Article 11 establishes that the financial statements of the central bank must be made according to the generally accepted norms and principles with international standards adopted by the Monetary Board at the proposal of the Bank Superintendence.

    Article 60 establishes that the President of the Banco de Guatemala must appear before the Congress of the Republic in January and July to render accounts on the results of the execution of the monetary, exchange rate and credit policy of the country.

    Article 62 refers to the monthly report of the general balance of the Banco de Guatemala, as well as the annual report on its financial statements, and article 12 requires an external audit to the central bank


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    FAVORABLE EXTERNAL

    MONETARY

    POLICY

    ENVIRONMENT

    DISCIPLINED

    MACROECONOMIC

    STABILITY:

    SAVINGS

    MORE PRODUCTION

    FISCAL

    POLICY

    INTEREST RATE

    FACTORS:

    (LONG TERM)

    INVESTMENT

    SUSTAINABLE IN THE L.P.

    ADEQUATE

    ECONOMIC

    ADEQUATE

    • POLICY TO IMPROVE EFFICIENCY

    • Deregulation of prices

    • Commercial opening

    • Financial Liberalization

    • Privatization

    GROWTH

    INFRASTRUCTURE

    HUMAN CAPITAL

    (health and education)

    ADEQUATE

    BETTER USE OF

    FACTORS:

    PRODUCTIVITY

    • INSTITUTIONS

    • Property rights

    • Regulatory Agencies (superintendence)

    • Autonomy of the central bank; fiscal regulations

    • Social Security

    • IMPERIO OF THE LAW

    • POLICY TO IMPROVE INSTITUTIONS

    • To CREATE markets

    • To REGULATE markets

    • To STABILIZE markets

    • To LEGITIMIZE markets

    SOCIAL INTERNAL

    HARMONY

    Economic Policy and Growth:


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    The propitiate stability of prices:

    • savings, investment and productivity

    • Better life quality when preserving the value of salary, of savings and of pensions

    • Interest rate (long term) lows

    • Reduction of public debt service (which frees resources for social investment), of business and home debt

      STABILITY IS INDISPENSABLE FOR ECONOMIC GROWTH


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    Framework of the economic policy in Guatemala, 1970-2006

    Central Bank Autonomy

    Monetary Policy

    Exchange Regimen

    Financial Policy

    Mobility of Capital

    Fiscal Policy

    Expenses

    Income

    Explicit Inflation Goals

    Flexible ER with an exchange rule

    Legal and Solidity Reform

    Full liberty forcapital (Free Negotiation Law)

    New Organic Law

    SAT

    Banking Crisis

    Exchange Dsorder

    Zero Credit to the government (constitu-tional reform)

    Moderate Management

    Liberalization without appropriate regulation

    Tributary Reform

    Monetary Aggregates

    Multiple ER Big devaluation

    Control exchange

    Gradual adjustment

    Absolute loss of discipline

    Regulation for exit and entry of capital

    Fiscal Dominance: credit to the government

    Convertibility Till

    Financial Repression

    Structural Weakness

    Moderate Management

    Fixed ER


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    Thank you very much!

    MAGL

    June, 2006


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