Central banks’ mandates define the main objectives of the monetary authorities in a given economy. They are typically laid down in the most important types of legal acts such as national constitutions (as in the case of the Central Bank of Colombia), treaties (as in the case of the European Central Bank), or acts of parliament (as in the case of the Bank of England).
Basic tasks of central banks
Based on the function of the mandates (i.e. the indication of the basic task that the central bank is supposed to pursue) and their location (i.e. written down in the legal acts governing the functioning of the monetary authorities), we can identify two important features of these documents.
Firstly, the mandates are usually formulated in broad terms, which enables central banks to conduct monetary policy in a flexible manner. Secondly, the mandates do not change very often, which supports the stability of the central banks’ activities.
With regards to the first, it’s worth noting that the mandates frequently include terms such as “currency stability” and “prosperity”. Their interpretation could therefore lead us to the conclusion that the central bank should take care of the internal and external value of the domestic currency, as well as minimising unemployment and maximising production.
In particular in the case of central banks using the inflation targeting strategy, which are the main focus of this analysis, it is necessary to “translate” the mandate into a specific numerical inflation target.
This means that wording such as “price stability” and “protecting the value of the domestic currency” may translate to an inflation target at a level close to 2 per cent in some countries, while in other countries with a similar sounding mandate the inflation target could be set at around 4 per cent.
Who determines the inflation target?
The key question, of course, is who has the authority to interpret the mandate. Analysing once again the group of countries pursuing the inflation targeting strategy (that is, countries in which the primary task of central banks is to ensure price stability), we can see that various solutions are used: the determination of a numerical inflation target can either be the exclusive prerogative of the government, or the exclusive competence of the central bank, or it could be determined jointly by the government and the central bank.
Interestingly enough, we don’t see a clear relationship between the entity authorized to determine the inflation target, and the level of the actually adopted target inflation rates, although in the literature it is typically assumed that monetary authorities – in principle – prefer lower inflation than what is accepted by the governments. Given the fact that price stability is highly desirable, this is one of the arguments for providing central banks with far-reaching independence. In practice, however, in countries pursuing the inflation targeting strategy we don’t see significant differences in the preferences of central banks and those of governments as to the appropriate level of inflation. There are some countries where the government adopts a higher inflation target than in countries where the inflation target is determined by the central bank, but there are also cases where the reverse is true.
Financial stability, price stability, and economic growth
Apart from price stability, we can point out a few other elements frequently included in the central banks’ mandates. These include, for example, promoting sustainable and stable economic growth, maintaining full employment, preserving financial stability, and defending the international value of the domestic currency.
The specific provisions enshrined in the legal acts vary considerably between the individual countries, but the terms used in them could be assigned to several basic categories including price stability, economic growth, and financial stability.
The attribution of such great importance to economic growth, which in the case of many central banks is a part of their mandate alongside price stability, is consistent with a flexible approach to the inflation targeting strategy. After all, this approach is based on the assumption that the inflation target is to be pursued in a way that causes the least possible harm in the form of volatility or reduction of economic activity.
The central banks pursuing the inflation targeting strategy also take into account the objective of financial stability. They do this by reacting in a flexible manner to shocks, which are causing the inflation rate to deviate from the target. Such flexibility could be manifested, for example, in greater tolerance for prolonged periods in which inflation exceeds the target, if such a scenario is seen as conducive to financial stability.
As it has already been indicated, in addition to being formulated in rather broad terms, another important feature of central bank mandates is that they tend to be quite stable over time. This is understandable, considering that their main objective is to determine the long-term direction of the monetary authorities’ activity. Many of the currently applicable central bank mandates have been enacted in the 1990s, when the inflation targeting strategy started gaining increasing popularity.
Modifications introduced after crises
It’s worth noting that central bank mandates have been modified in response to changes occurring in the economy and the accumulated experience of conducting monetary policy in certain conditions.
In this context, we could point out that while in the past the main problem encountered by the monetary authorities was mostly excessive inflation, at present in many countries we are dealing with a permanently reduced inflation rate. Another challenge that most central banks had to face was addressing the consequences of the recent crises.
One example of that could be the United Kingdom, where the mandate of the Bank of England was extended as a result of the lessons learned from the global financial crisis, which erupted in 2008. Starting from 2012, the objective of promoting financial stability became the additional task of the Bank of England alongside maintaining price stability.
Another interesting case are the recent changes introduced in the mandate of the Reserve Bank of New Zealand. The previous mandate, introduced in 1989, focused solely on price stability. This wording of the central bank’s main task was supposed to reduce the dilemmas faced by the monetary authorities as in the preceding period they were supposed to implement a mandate with multiple objectives, encompassing inflation, economic growth, and employment.
The lack of clarity regarding the hierarchy of these objectives may have reduced the effectiveness of the central bank’s monetary policy. The replacement of a mandate consisting of multiple objectives with a single-objective mandate gave rise to the inflation targeting strategy, which started to gain popularity from that point on.
However, in 2018, New Zealand’s authorities once again expanded the scope of the central bank’s mandate by adding the objective of supporting maximum sustainable employment starting from 2019. At the same time, price stability still remains a crucial objective. New Zealand’s central bank has stressed that the changes in its mandate will not fundamentally affect its monetary policy strategy, as it will continue to pursue a flexible version of inflation targeting.
A debate on the possible extension of the central bank’s mandate is also currently underway in Sweden. At present, the main objective of the monetary policy pursued by the Riksbank is to maintain price stability. Meanwhile, the potential change would involve the inclusion of the additional task of supporting the balanced development of production and employment.
No fundamental changes in monetary policy
As it has already been pointed out, in the case of central banks pursuing a flexible version of the inflation targeting strategy, it doesn’t seem likely that an extension of the mandate could lead to any significant changes in the conduct of their monetary policy.
This applies in particular to the Reserve Bank of New Zealand and the Riksbank, which are among the central banks with a long history of conducting monetary policy pursuant to the inflation targeting strategy.
Meanwhile, with regards to the central banks’ current response to the recessionary trends that have affected the world economy in the aftermath of the coronavirus pandemic, it can be concluded that — looking from the perspective of central bank mandates – the activities undertaken in the area of monetary policy easing should be seen as consistent with the monetary authorities’ efforts to fulfil their statutory objectives.
The views expressed in this article are the private views of the author and are not an expression of the official position of the NBP