The year of living dangerously: On the selection of the Bank Governor and his challenges

Posted in economics by jrahman on June 23, 2009

On 29 April, the Government appointed Dr Atiur Rahman as the Governor of the Bangladesh Bank. The appointment has been greeted positively by many because of Dr Rahman’s truly inspirational life story, understanding of development economics, and interest in Tagore’s work. Some has commented that the appointment is an evidence of the Government’s ‘pro-poor’ bona fides. However, little has been said about the judiciousness of the appointment given the challenges before the Bank, and qualifications and experiences that might have helped the Governor in overcoming them.

Central bank governor’s job is perhaps the most technocratic of all policymakers. The central bank’s function is to maintain stability in the macroeconomy and the financial system. In the advanced capitalist world, macroeconomic stability has come to mean price stability. For a developing economy, it could also mean defending the exchange rate or maintaining solvency of the government. Financial system stability means maintaining a functioning banking system, keeping the credit flowing, and acting as the lender of the last resort.

Heading the central bank requires a solid understanding of macroeconomic theory and empirics, and practical experience in banking and finance. The central banker needs to have years of experience that allows one to develop a thorough understanding of the data, or network in the industry that allows one to make a few phone calls and get a feel for things in a rapidly evolving world. The central banker needs to complement rigorous analysis that is founded on a solid understanding of macroeconomic theory and practice with subjective judgement that comes only with experience.

Given the above, it would appear that a serving Deputy Governor might have been a better choice. Such a pick would also have boosted professional morale and commitment to the organisation amongst the staff, and enhanced the Bangladesh Bank as an institution.

So much for generalities, what about some specific challenges the new Governor might face?

One of the biggest risks facing our economy involves remittance. Forget about a complete drying up of the overseas labour market. Even a less catastrophic scenario like a sharp slowdown or fall in remittances will place the Bangladesh Bank in a difficult position. Our modest current account surplus might turn into a deficit. If the deficit becomes too big or eventuates too quickly, taka might come under pressure. While an orderly depreciation of taka may be beneficial for the exporters, a sudden depreciation might lead to full blown capital flight and a balance of payments crisis. If this happens, we might have to seek assistance from the IMF, who will ask for conditionalities that may or may not be good for us. And even if there is an orderly depreciation of taka, it will mean imports will become more expensive. If taka were to depreciate against the Indian rupee, food prices will rise, like they did in recent years.

It’s not clear how an understanding of development economics will help with policymaking in case of a remittance crisis.

More generally, the Governor has promised to be ‘pro-poor’ in policymaking. It’s not clear what this would mean in practice.

Other than maintaining macroeconomic and financial stability, central banking has little, if anything, to do with development and poverty alleviation. It is not possible to do more than one task with one instrument. And central banks have essentially one instrument — supply of money. As is being witnessed around the world, central banks in most advanced economies have not had much success in maintaining macroeconomic stability while keeping their financial sector from going haywire. The task of the Bangladeshi central banker is much harder as it is. The Bangladesh Bank should not have to do poverty alleviation, there are other agencies who can do that more effectively.

Let us think beyond the current recession. There is a strong literature of political business cycle theory that shows that in all democracies, governments tend to spend beyond their means before election. How damaging this vote-buying depends on how strong the economic institutions are, with the central bank being the key institution. Suppose our Government were to embark on a pre election spending spree by 2013-14. What will happen if the Bangladesh Bank, in a misguided attempt at being ‘pro-poor’, accommodates that spending spree?

History is full of such episodes, almost all ending with hyperinflation. The central banker has to be someone who can maintain independence from both the rich end of town as well as the government. The Governor will have to say no to the garments owners if they want a depreciation of the taka if such depreciation pushes up prices. He will have to stand firm against the banking sector if he believes a tightening of regulation is warranted. And most importantly, he will have to refuse the Government’s wishes to borrow if that is the right course of action.

Will the Governor be able to do this?

Before the recent election, he was involved more in the political side of the Awami League campaign than economic matters. Whereas previous Bangladesh Bank Governors had been appointed for their professional credentials, the current pick smacks far too much of political favouritism.

Dr Atiur Rahman takes over during the worst storm to batter the global economy in living memory. He will need all his wits, and then some more, to guide us through. To navigate this treacherous terrain, one hopes he builds up a strong team noting some of these challenges mentioned.  Let’s also wish him good luck in his tasks ahead, for he will need it, badly.


14 Responses

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  1. Shamshir said, on July 7, 2009 at 4:35 am

    Great post!
    Love the shout-out to Alesina et al too!

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