Why is the CNB independent?

Central bank independence is a key precondition for the successful implementation of monetary policy and hence for sustainable non-inflationary economic growth. Ever since it came into being in January 1993, the CNB has had a high degree of independence from political structures when performing its statutory functions. CNB independence is laid down in the Act on the CNB (pdf, 238 kB) (No. 6/1993 Coll.).

Why is central bank independence important?

Independence is important for the fulfilment of the central bank´s primary monetary objective, which for the vast majority of central banks is to maintain price stability. The importance of price stability ensues from empirical experience with the world economy, which confirms that high and volatile inflation has negative economic consequences. These manifest themselves through several channels. As a rule, higher inflation implies greater inflation volatility, causing investors to focus more on short-term financial investments and on hedging against inflation, and consequently less on longer-term productive investments. Higher inflation is associated with higher nominal interest rates, which stimulate inflow of short-term risk capital. When inflation is high in the long term, inflation and depreciation expectations become fixed in the decision-making of economic agents. Unforeseen high inflation causes several other economic distortions that reduce the growth potential of the economy. For instance, it redistributes income from creditors to debtors, it erodes the value of savings, and it distorts the tax system. Price stability is also important to the Czech Republic for normative and exogenous reasons - it is a condition for acceptance into the euro area.

The importance of central bank independence comes to the forefront here primarily because politicians may seek to compel the central bank to adopt measures that although in the short-run may boost economic growth, in the long run will lead to an undesirable rise in inflation. Economic growth will meanwhile return to its original level, or even sink to a lower level (as a result of the higher inflation). A sufficient degree of independence from political influence allows the central bank to resist such pressures.

What, specifically, does CNB independence entail?

Personal independence consists in curbing any political pressures that may be exerted during the appointment and dismissal of members of the CNB Bank Board. The seven-member Bank Board is appointed and relieved from office by the President of the Republic without the assistance of the government. The CNB Act also rigorously defines the reasons that would justify the dismissal of a Bank Board member (failure to fulfil the conditions required for the performance of his/her duties or being guilty of serious misconduct).Institutional independence means that when carrying out the tasks and duties conferred upon it by law and when performing its other activities, the CNB Bank Board may not seek or take instructions from the President, Parliament, the Government or any other body. Operational independence consists in CNB autonomy when formulating inflation targets and setting the instruments required to achieve them. The CNB is required to set the exchange rate regime only after discussion with the Government, but this must be without prejudice to its primary monetary objective. The CNB and the Government inform each other on matters concerning the principles and measures of monetary and fiscal policy. Financial independence consists in a prohibition of any direct financing of the public sector or of the bodies it controls. The CNB is not a part of the public budgets of the Czech Republic. On the contrary, it is strictly separated from them by law and covers its operating expenses from its own revenues by law. The CNB is not funded by taxes and so its expenses are not covered by taxpayers. The CNB operates under a budget approved by the Bank Board. This is broken down so as to give a clear view of the CNB´s property acquisition expenses and operational expenses. At the end of the financial year, the CNB is required to compile a profit and loss account and to have it verified by an external auditor. This is then used as the basis for an annual financial report, which is submitted to Parliament for review. The CNB is also required to disclose regular ten-day balance sheets on its financial position.

Independence and transparency

The CNB's high degree of independence goes hand in hand with a high degree of monetary policy transparency. The public is kept informed about the CNB's primary monetary policy objective and about the nature of the inflation targeting regime through which this objective is fulfilled. The CNB also keeps the public informed about its inflation target figure, about its inflation forecasts and the risks attaching to those forecasts, and about its monetary policy measures and the reasons for implementing them. To this end, the CNB issues quarterly Monetary Policy Reports, which are submitted to the House of Deputies (the lower house of the Czech parliament) and made public on the CNB website. It also makes use of articles in the press and in professional journals, lectures, speeches by Bank Board members and so on.

A temporary curbing of the CNB's independence

An amendment was made to the CNB Act (pdf, 178 kB) in 2000. The original aim of this amendment (No. 442/2000) was to harmonise the Act with the legislation governing the European Central Bank. However, some additional revisions above and beyond the harmonisation changes were incorporated into the amendment on its way through Parliament. In effect from January 2001, these changes significantly curbed the CNB's independence. They concerned the following measures in particular:

• matters relating to the inflation target and the exchange rate regime had to be consulted with the Government, and agreement had to be reached with the Government before the inflation target and the exchange rate regime could be set;
• the Bank Board had to approve only the budget for activities associated with pursuing its primary monetary objective, whereas the CNB´s operational and investment budget had to be approved by the Chamber of Deputies of the Parliament of the Czech Republic.

The amendment also included a proposed change to the mechanism for appointing Bank Board members. Under this amendment, they were to be appointed by the President of the Republic at the proposal of the Government.

These revisions received a negative response from many in professional circles and from numerous significant international institutions, for instance the International Monetary Fund, the European Commission and the European Central Bank. The Constitutional Court of the Czech Republic found the revisions to be unconstitutional, and they were consequently repealed with effect from 3 August 2001. In May 2002, a further amendment to the Act on the CNB (pdf, 178 kB) (No. 127/2002) entered into force, which restored the statutory independence of the CNB to its position prior to the 2000 amendment. The CNB remains independent of political structures and determined to employ its monetary policy to foster a sustainable low-inflation economic environment.