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New book puts the lender of last resort under the spotlight
Author: Petro Mostert
Published: 20/06/2024
  • Prof Stan du Plessis, Chief Operating Officer of Stellenbosch 肆客足球, co-authored a new book on the importance of Central Bank independence.
  • New book place spotlight on governments to respect the role and mandate of central banks stop the pressure on these banks to accommodate a country's fiscal needs.

 What began as a series of articles on the lessons learned from the Global Financial Crisis (also known as the Great Recession) of 2007–2008, brought on by reckless or lax lending standards and resulted in a housing market bubble, evolved over six years into a 266-page full-length book that makes a strong case for the restoration of central banks' independence and reiterates their narrow and appropriate goal of low and stable inflation over the medium term.

The book, Reconsidering Central Bank Independence, flows from the research and writing of three scholars over six years, Prof Stan du Plessis, Stellenbosch 肆客足球's Chief Operating Officer, Prof Andreas Freytag, Professor of Economics at the Friedrich-Schiller-肆客足球 Jena, where he heads the Schumpeter Center for Research on Socio-Economic Change (JSEC), and Honorary Professor at Stellenbosch 肆客足球, and Dr. Dawie van Lill, currently a Senior Macroprudential Specialist at the South African Reserve Bank.

Reconsidering Central Bank Independence takes you back in time, following the development of central banking before the modern era and the events of that century leading up to the 2007–2008 Global Financial Crisis (GFC). The book also covers the crises within the Eurozone, the COVID-19 pandemic years, and the Russian invasion of Ukraine in February 2022.

Only during the first decades of the twentieth century did central banks, with their modern roles and responsibilities, emerge as a complete package. The forerunners of the first Central Bank as we know it today — the Sverige Riksbank of Sweden — were founded in 1668, followed by the Bank of England (BoE) in 1694 and, much later, the Banque de Franc in 1800. There are currently 179 central banks in the world, and their primary responsibilities include serving as the government's banker, controlling the issuance of banknotes and coins, and acting as the financial industry's regulator and the lender of last resort.

As a renowned economist, "rated" researcher, earlier president of the Economic Society of SA, and a former member of the "Harvard Group" of economists who advised the South African government on monetary policy during the Mbeki-era, Du Plessis's vast experience in monetary policy saw him contributing to various books and academic papers on monetary policy over the years.

Du Plessis says a common theme throughout the book is the unbearable temptation among governments to solve their fiscal policy problems through the powerful instruments available to a Central Bank. This is a temptation government must resist and the book concerns the importance of the resulting central bank independence. The message is of contemporary importance given the pressure on central banks globally in recent years.

During the financial crisis of 2007-2008, the most important objective of the central banks was to prevent a repeat of the Great Depression in the 1930s. "It is important to remember that the collapse of the stock market in 1929 did not cause the Great Depression, but rather the failure of central banks to support solvent commercial banks when their liquidity came under pressure a year later. At that time central banks (especially the Federal Reserve Board in the USA), therefore, did not fulfil their role as the lender of last resort to stabilise the financial sector; they neglected their most important duty."

The book's cover — a man pushing a large cart across the tram line in Weimar, Germany, during 1922 — illustrates the consequences of hyperinflation with a wagonload of banknotes. "In the middle of 1922, you could exchange 320 marks for one US$, and in December of that same year, the mark declined to 7 400 marks per US$. By November 1923, one US$ was worth 4 210 500 000 000 marks, a number one struggles to read," says Du Plessis. No wonder they needed a trolley to transport all that money, and what has become known as “wheelbarrow inflation".

"Even though central banks managed to stabilise the financial sector after the 2007-2008 financial crisis, the economy grew slower than expected, and there was pressure on some of these banks to intervene in uplifting the economy – hence, broadening their mandate beyond that of protecting the value of the currency and securing price stability," said Du Plessis.

Du Plessis says we need to remember that the Central Bank's independence is also a "negotiated independence," and as quickly as the government can give this independence to the bank, it can also take it away. As the authors state in the first chapter, "This tension between the need for independence by the central bank and the desire for society to hold the same bank accountable in a democratic setting runs through this book."

"In the recent past, we saw how Turkey found themselves in another currency crisis when the country's President Recep Tayyip Erdogan fired the head of the central bank, Governor Naci Agbal, after the former finance minister hiked interest rates to counter a sharp increase in the inflation rate. After a relatively stable period, Turkey again ended up with inflation of 150 percent."

Throughout the book, the authors are very complimentary toward the South African Reserve Bank and how it has been managed throughout the various crises in the world.

"The Zuma administration could not penetrate the Reserve Bank. Of course, the former administration tried very hard to penetrate treasury in what everyone remembers, the appointment of our "Weekend Special" Minister of Finance Des van Rooyen.

"What stopped the President was the capital markets," says Du Plessis. "The rand plummeted so precipitously that even President Zuma got frightened and reversed course. This reminds me of President Harry Truman — the 33rd American president's answer to the question at the end of his term: "Should you be born again, would you like to become the President of the US once again, as this is the most powerful position in the world." Truman said no, the bond market is the most powerful force on earth. The capital markets determine what the government can and cannot do. Like President Zuma, so too for President Erdogan who also had to give in and reverse his unorthodox monetary interventions."

Du Plessis says that, unfortunately, the Zimbabwean economy was never linked to any of the capital markets. Therefore, it collapsed the way it did and ended catastrophically with hyperinflation. The result was the complete destruction of the Zimbabwean economy.

Du Plessis referred to a quote in John Maynard Keynes's book The Economic Consequences of the Peace (1919), where Keynes argued that the Treaty of Versailles's punitive terms would lead to further global conflict. Keynes predicted that hyperinflation would be the consequence of the exaggerated fiscal demands of the peace treaty.

"Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch its currency. Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction and does it in a manner which not one man in a million is able to diagnose," argued Keynes at the time.

Du Plessis says after the financial crisis, there is concern about a new and broadened mandate for central banks where they accept responsibility for long-term economic growth, unemployment, and even for the green transition of the economy. "Although these are all great goals to have, the lessons from the 20th century taught us these are the government's agenda, and we should not use the central banks' balance sheets to achieve them. When the lines between central banks and the fiscal authorities become blurred, you end up with an irresponsible monetary policy and eventually unacceptable inflation."

"Around the globe, we saw that after forty years of low inflation, for the first time in 2020, high inflation started to run away from central banks. It was no surprise to us. Neither was it surprising that the central banks struggled to get the inflation under control. The reason was that they no longer focused on inflation."

Du Plessis said this was not the case in South Africa, where our 1921-established Reserve Bank kept its eyes on that one single goal and maintained its independence throughout the past fifteen years. "The only way one could restore the status quo for central banks across the globe was to ensure there is no confusion over what the role and responsibility of both the central bank and the government is. This means you must limit the role of the central bank to low and stable inflation and ensure their independence without political interference. Only then will the central bank be able to succeed in its mandate."

 Du Plessis is already working on his next book, this time with his PhD promotor, Prof Ben Smith, whom he regards as one of the most influential people in his career. "This is more of a history book. It covers the history of monetary policy since the year 2000."

Du Plessis says it was not the easiest task to write a book while he was extremely busy as the Chief Operating Officer of SU, but he was grateful for his co-authors' patience.  

Du Plessis believes university executives should keep in touch with and be actively involved in the academic environment. "It is important to understand the world from an academic perspective. And the best way to do that is to be one yourself."

His active involvement in the academic and research environment is evident in him being acknowledged twice amongst SU's leading researchers by the Deputy Vice-Chancellor of Research, Innovation, and Postgraduate Studies since he took on the role of COO.

Cambridge 肆客足球 Press published the book at the beginning of May this year. The official book launch was held at Die Stal, SU's Alumni Clubhouse on the Coetzenburg grounds, Stellenbosch on 18 June 2024.

For enquiries
Petro Mostert

M 0823346193

E petromostert8@gmail.com


The book is available at Oxford 肆客足球 Press online