The book is the latest addition to economics literature in Sri Lanka. The basic thesis of the book is ‘good money’ creates wealth and growth while ‘bad money’ would retard this. This observation was made by Copernicus in 1529 AD and Thenuwara shows the validity of this observation in the modern day world.
The book has 11 chapters. Some of the chapters explain basic economic concepts in the context of monetary policy while others show how monetary policy has worked and the prerequisites for positive results. The underlying theme of the book is the need for a Central Bank to conduct independent monetary policy and thereby keep inflation low, which is essential to achieve higher economic growth.
When too much of money circulation is not matched by an increase in the supply of goods, the goods’ prices increase and creates inflation. If demand for money is stable, a Central Bank can carry out monetary targeting (quantity of money) in its monetary policy to keep inflation at a low level. In the real world however, the demand for money is unstable. Thus, Central Banks adopt different monetary policy regimes at different times and they select the most efficient monetary policy instrument or a combination of instruments to reach the desired credit and money targets.
Several instruments can be used to conduct monetary policy: interest rates, the statutory reserves, moral suasion, central bank communications, and administrative instruments to control aggregate demand. The book shows that the most effective and convenient instrument is the interest rate for conduct of monetary policy. But the market players should be sensitive to the interest rates. If the government is a major borrower in the market, and does not change its demand for credit when changes occur in the interest rates, then monetary policy becomes ineffective. Chapter 9 highlights the need for proper coordination between monetary authorities and fiscal policy officials to obtain best results from monetary policy.
Chapters 5 and 6 deal with exchange rate management and the global economic crisis, respectively. Exchange rate management is closely linked to monetary policy. After the heavy loss of international reserves during the recent global economic crisis, some Central Banks realized that defending the exchange rate is not compatible with independent monetary policy and open capital account -- known as the ‘Impossible Trinity’. Either the Central Bank undertakes a devaluation or approaches a funding agency like the IMF for a loan to boost up the reserves, and there was no case for resisting both. Thenuwara argues that the Central Banks have always been either part of the causes of the crisis or part of the solution to the crisis.
The 10th Chapter is on the independence of the Central Bank. The key duties of the Central Bank should be to ensure price stability and financial system stability. Some Central Banks are entrusted with a large number of other functions unrelated to the key objectives. For instance, the Central Bank of Sri Lanka (CBSL) is encumbered with management of government funds – EPF, and management of public debt, and these have conflicting interests with the key objectives of the bank.
It is argued that the CBSL has no legal identity and it is only the Monetary Board that has a legal identity; thus, what matters is the independence of the Monetary Board. The book highlights a few areas which have contributed to the dilution of the independence of the Monetary Board: (1) Section 89 of the Monetary Law Act permits the Central Bank to grant provisional advances to the Treasury up to 10% of the estimated revenue. In the past, the Treasury has always availed of this facility fully, thus preventing the Central Bank from controlling this injection of money to the economy, (2) the Central Bank is the banker to the government – thus causing difficulties in controlling money supply, and (3) the Secretary to the Treasury being a member of the Board (ex-officio) may influence the Board to accommodate the fiscal needs of the political establishment.
There are a few areas in the book where some questions could be raised. First, in the final chapter, the book argues the case for a regional Monetary Integration for bringing more binding commitment to monetary discipline. This idea of course requires harmonizing of macroeconomic policies – which would be difficult given the fiscal indiscipline in the regional members of South Asia.
Second, is the re-emergence of Keynesian economic policy after the recent global economic crisis where a fiscal stimulus was injected by many countries to rejuvenate their economies, rather than sticking to the monetarist doctrine of inaction. The rapid global recovery shows that the Keynesian formula has generally worked. This area should have received more attention in the book where better harmony could be worked out between fiscal policy and monetary accommodation to minimize the adverse consequences of a fiscal stimulus after a crisis.
The book is written in very simple language without using much mathematical jargon. One need not be an Economist to read and understand the book and it draws examples from various countries and is not confined to the Sri Lankan scenario alone.
It is very clear from the book that the author had a deep understanding of Central Banking and monetary policy. Although he is no longer serving the Central Bank, he has shared his experience and made a significant contribution to understanding monetarypolicy. The book will be useful for Central Bankers, policy makers and economists in Sri Lanka and it is an essential reading for anyone interested in the subject. |
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