Tuesday, September 6, 2011

Central Banks as Agents of Development

The Overlooked Role of Credit Policy
UN University Study

What is the precise role of a central bank? What are its tools? While the common-consensus has focused on the central bank's role concerning price-stability and economic growth by means of manipulating key interest rates and money supply. During times of crisis, (as we have seen), this has been expanded to managing the supply of other financial instruments as well. e.g. MBS, bonds.

What we have not considered lately are questions about not simply how much credit and money supply there is in the economy, but also where and under which conditions this money and credit is allocated in the economy. Nevertheless, these questions are highly relevant to both crisis response and to economic development. In other words, the current paradigm in monetary policy only considers half the story. 

Front-page news or not, Many of the world's principal central banks actually have thought about this question  since the 2008 collapse of Lehman Bros. Since then, the Liability side of central bank balance sheets in the US, EU, and UK (representing funds flowing from the banks into the economy at large) have undergone broad diversification.

The UN University Study
In this UN University study focusing the role of credit policy in development economics, the history of central bank involvement in sectoral development policy, industrial policy, export-promotion. The tools of these policies were primarily credit allocation, subsidized loans, and capital controls. They were used to:

1.       To finance government debt at lower interest rates
2.        to reduce the flow of credit to  the private sector without raising domestic interest rates
3.       to influence the allocation of real resources to priority uses and
4.       to block channels of financial intermediation and thus to assist restrictive general monetary policy

This study outlines the historical role that credit policy in the industrialization of continental Europe, as well as the development the of  UK's financial sector. Japan's industrialization was also underwritten by strategically-placed funds and subsidized loans.

What does this mean for developing countries ?
The New York Federal Reserve’s historian, Arthur I. Bloomfield reported in 1957 “the central bank can seek to influence the flow of bank credit and indeed of savings in directions more in keeping with development ends.” The fact is that virtually throughout their history, central banks have financed governments, used allocation methods and subsidies to engage in ‘sectoral policy’ and have attempted to manage the foreign exchanges, often with capital and exchange controls of various kinds.

This is was what developed countries needed then, and it is what developing countries need today.

About the Author:
Gerald Epstein is the chair of the department of economics at University of Massachusetts Amherst since 1997 and a former UN University researcher. He holds a PhD in Economics from Princeton University. 


  1. Interesting, but it might overlook the capacities of central banks in development countries. These banks often lack independence and politicians use them to pursue short-term objectives rather than long-term development goals. Moreover, these countries often do not have proper functioning national credit markets. In order that central banks could play a role in development countries, one should first tackle these issues, in my opinion.

  2. Yes, I think that independence is a tricky issue. I think that there is no one-size-fits-all approach. Even if you are a strict believer in Central Bank independence, then how do you construct that legally speaking? Each country has to find its own way.

    As for functioning capital markets, I think that the historical credit policy role may pre-date the existence of developed credit markets in some of the countries who are rich today.