Fiscal Aspects of Central Bank Independence

Abstract

Most macroeconomic models treat the central bank and the trea- sury as a unifled entity. The balance sheet of the central bank is therefore implicitly treated as an accounting flction. While this is often realistic, the central bank balance sheet has implications for central bank independence. There are wide difierences in the nature of central bank balance sheets today, with the US and ESCB balance sheets nearly at the extremes. The reasons for and implications of these difierences are studied here. I. Introduction There are two ideal models of a central bank, of which actual central banks are usually a mixture. In type F, which is close to describing the US Federal Reserve system, the central bank's balance sheet is always perfectly hedged, with short term interest-bearing nominal bond assets and high-powered money liabilities that leave almost no risk of balance sheet problems. There is a single government budget constraint, re∞ecting the certainty that mature government bonds can always be redeemed for high powered money and the fact that there is no doubt that potential central bank balance sheet problems are nothing more than a type of flscal liability for the treasury. In type E, which seems to be the model underlying the constitution of the ECB and which (in an extreme version) is close to matching currency-board arrangements like that in Hong Kong, the central bank holds assets whose return distributions do not match those of its liabilities, but are intended to act as reserves, guaranteeing a lower bound on the value of its high-powered money liabilities in terms of some other store of value. In this model, the central bank budget constraint is distinct from that of the treasury (or in the case of the ECB, treasuries). Mature nominal government debt might not, in some circumstances, be convertible at par into high-powered money, and conversely it is not obvious