Banco De La Republica

The Central Bank in Colombia

Alberto Alesina Alberto Carrasquilla Roberto Steiner

FEDESARROLLO

1 WORKING PAPERS SERIES . DOCUMENTOS DE TRABAJO

Agosto de 2000 q No. 13

Revised version, June 2000

THE CENTRAL BANK IN COLOMBIA*

Alberto Alesina, Harvard University Alberto Carrasquilla, Fedesarrollo and Universidad de los Andes Roberto Steiner, Universidad de los AndesAbstract
In the last decade the issue of the optimal degree of central bank independence has been at the center of attention of academics and policymakers in many countries. The direction of institutional reform has almost universally been toward making central banks more independent from political pressure. The motivation of this move is linked to an increased emphasis on price stability as the mainor only goal of monetary policy after two decades of exceptionally high inflation rates. Colombia has made an effort in reforming a complex set of monetary institutions, which for over two decades delivered a persistent, moderate rate of inflation. The central bank reform -along with the elimination of many indexation practices, the liberalization of financial activity and the reduction of tradeand capital account barriers- delivered substantial progress. This paper argues that a reduced set of "second generation" reforms aimed at correcting limitations that were maintained may further deepen these accomplishments. We propose to make the board of the bank smaller and to remove any members of the executive from it. An appropriate timing of appointments should also create stability in theboard. Lengthening the appointment tenure of the governor and board members, together with a staggering of terms, reduces the risk that every new executive brings about an entire new board, or at least a new majority in the board of the bank. The central bank should also have a clear mandate that sets inflation control as its overarching goal. This is important because the recent involvement ofthe Constitutional Court in the matter of the relative precedence of inflation control over other goals raises much confusion. Finally, we conclude that the central bank is the institution better suited to supervise the financial sector. While arguments pro and against using the central bank as the financial regulator certainly exist, on balance we conclude that for a middle-income country this isthe best solution.

* We thank Roberto Perotti and participants at the group meeting in Cartagena for comments and Miguel Braun for excellent research assistance. Maria Mercedes Carrasquilla provided outstanding organizational support.

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I. Introduction
In the last decade the issue of the optimal degree of central bank independence has been at the center of attention of academics and(more importantly) of policymakers in many OECD and developing countries. This is an issue of great and burning importance, especially in two situations: in the case of countries that have experienced macroeconomic imbalances and are implementing "structural reforms"; and, second, in the case of the creation of new political entities, in need of new monetary institutions, like the European Unionand several newly born countries around the globe1. The direction of institutional reform has almost universally been toward making central banks more independent from political pressure. Recent examples include the United Kingdom, Canada and New Zealand in the OECD and Chile (1989), El Salvador (1991), Argentina (1992), and Mexico (1993) in Latin America. The new European Central Bank, modeled tothe Bundesbank, is one of the most autonomous central banks in the world. The motivation of this move is linked to an increased emphasis on price stability as the main or only goal of monetary policy after two decades - the seventies and eighties - of exceptionally high inflation rates in both developing and OECD countries. Colombia had its own central bank reform in 1991. The intention of the...