ROLE IN PUBLIC DEBT SERVICING

ROLE IN PUBLIC DEBT SERVICING

Incurring of public debt can be viewed from two perspectives:

• strategic instrument of the fiscal policy makers
• potential relationship between debt policy and discretionary monetary policies
The second best:
Authorities can stick to the inflation rate that is declared at the start of each period
leads to the maximum level of social welfare when lump-sum taxes are not present

However…
Flaws in the political system might lead to deviating from the preferences of society
Changing monetary institutions is not the most appropriate instrument

Required:
A supplementary optimal debt target
Central bank, if independent, will prevent deficits by increasing government borrowing costs by short-term
interest rate rises and by refusing to lend directly to the government

A combination of fiscal deficits and a tight monetary policy of retaliation is likely to lift the interest rates at
which markets can fund fiscal deficits

In addition, introducing central bank laws restrict the capacity of a bank to directly provide funds to
governments or give it more leverage over the terms of borrowing, including the maturity and cost of lending.
As a key general principle, that central banks should refrain from lending to the government, although this may
not always be possible depending on the level of development of the country.

In developing countries, government support from central banks may be required in the short run. The reasons
are:
• Government revenues undergo seasonal fluctuations
• Capital markets are shallow
Suggested operating structures
• Loans at short-run maturity should be granted
• The cost of loans to the government from the central bank should be fixed by law and based on market
interest rate
• The government's central bank loans should have an upper cap
• The legislation should shield the central bank from the event that its duty is not paid on time by the
government
• The right to borrow from the central bank can only be given to the central government
• The terms on which the central bank loans to the government should be reported as a good practice of
accountability
An independent central bank:
Decreases the risk of inflation
Risk premiums decrease even if governments issue longer-term bonds
Government has less impact on monetary policy
Government unable to take advantage of long periods of high inflation.
Advises debt management to pay closer attention to budget risks.
MEASURING CBI INDEX
It is very difficult to define and construct a relevant index for CBI as it is a multidimensional concept. This
difficulty is even more intensified by the sensitivity of the empirical results to the indicator of CBI used.
Three reasons behind the differing results:
(i) the components contained in the indicators are differ due to their focus on different aspects of CBI;
(ii) researchers interpret central bank status as per their own differing criterion;
(iii) indicators are constructed using the same components, but their combinations have different weight
Ahsan, Skully and Wickramanayake Index-Model
CBIG index (CBIGOverall): 1. Legal (CBIGLeg) 2. Political (CBIGPol) 3. Price stability objectives
(CBIGPStab) 4. Exchange rate Policy (CBIGForx) 5. Monetary policy and deficit financing (CBIGMonpol) 6.
Transparency and accountability (CBIGAcctrans).