In recent days, the Executive Power reported that the Bank of Mexico would increase the interest rate by half a percentage point, that is, by 50 basis points, which the central bank had not yet announced. This caused surprise and concern in different financial media. Later he apologized for getting ahead of himself, but because he thought that information was already public.
An important concern in this regard is that some might consider that the bank is following instructions from the federal government, that is, that it is losing autonomy in its monetary decisions. Another concern is that if some participants have relevant information about what the bank is going to do before the rest of the market, that is, they have relevant information in a relevant way, they can make decisions to the detriment of others, which is penalized in the majority of the countries. This has significant negative repercussions both within the country and abroad. However, the vast majority of the population is not aware of the consequences and high costs that the bank could reduce or lose its autonomy.
Central banks have two major responsibilities which are 1) The proper functioning of the country’s payment system, since it is the bank of banks and a relevant regulator of the financial system and two) Good management of monetary policy by controlling the amount of money, so that the economy works correctly, while avoiding increases in inflation.
The creation of money is an important invention that has fostered economic growth, facilitates business transactions, as well as savings and investments, and many other positive features. However, it exists to the extent that people trust it and believe that it will retain its value in the future, as well as that it will be accepted by others now and in the future. When people lose confidence in money, they stop accepting it and saving in the financial system and prefer to have other goods in their possession, thus raising their prices, that is, causing inflation. Then the price race begins, that is, I buy something now, even if I don’t need it, because later I won’t be able to buy it.
Our nation had periods of high inflation, even above 100 percent a few decades ago, as the central bank financed the federal government’s deficit by issuing money in excess of the economy’s capacity to absorb it. This led to high interest rates, a drop in savings and investment, especially in long-term projects, distortion in the markets, drastic devaluations of the peso and an impoverishment of the population, among other problems.
One of the main problems faced by central banks in the world is that governments force them to finance their expenses, since another alternative is to raise taxes is very unpopular or to finance themselves in the debt market, causing increases in interest rates.
One way to avoid this is through the autonomy of central banks, which are prevented from financing their governments and monetary policy decisions are not made by politicians, but by technicians, with the aim of avoiding inflation and allowing the proper functioning of the banking and financial system.
In our country, the decision was made to grant autonomy to the Bank of Mexico in the mid-1990s. Now the decisions are made by the so-called Governing Board, which is made up of five people with which a significant reduction in inflation and interest rates has been achieved.
However, financial market participants are always vigilant that central banks do not reduce or lose their autonomy and subordinate themselves to governments to finance their fiscal imbalances. This would cause a higher inflation rate, so interest rates will be higher to compensate for the loss of money’s purchasing power and higher exchange rate risks.