LFMI analysed a bill on amending the Law on the Bank of Lithuania and submitted comments and proposals to the Government, the Bank of Lithuania as well as the parliamentary Budget and Finance Committee and Economic Committee. A summary of LFMI’s comments and recommendations follows.
Price stability vs currency stability
The bill is aimed at bringing the Law on the Bank of Lithuania in line with the EU law and proposes to replace the main goal of the Bank of Lithuania, currency stability, with the goal of price stability. According to LFMI, the appropriateness of this amendment is highly questionable, given that the Bank of Lithuania would be assigned a goal (price stability) it has no instruments to pursue, while a goal (currency stability) that is completely dependent on the central bank’s activities and that the central bank can and should be responsible for would be eliminated.
Prices are determined by a multitude of factors that are beyond the control of the Bank of Lithuania or any other institution. The only facet of the dynamics of prices that does depend on the central bank is the quality of the money it issues. By ensuring currency stability, the bank eliminates the main negative cause of price changes and leaves prices that depend on many factors that are at play on the market. At present currency stability is guaranteed by the Law on Litas Credibility under which the central bank automatically secures the stability of the national currency against the anchor currency.
Currency stability is directly dependent on the central bank and national laws, whereas price stability is secondary to currency stability. Furthermore, the stability of prices per se is not of any value, nor an end in itself. Given all this, there is no need to change the current aim of the Bank of Lithuania (currency stability) in order to bring it in line with the European central banking system or the statute of the Bank of Europe, which defines price stability as the main goal of the European central bank.
The functions of the central bank
According to the bill, the new role of the Bank of Lithuania is defined as follows: the Bank of Lithuania “2) formulates and implements monetary policy,” “3) establishes a system for regulating the rate of the litas and announces the official rate,” and “4) manages and uses foreign currency reserves of the Bank of Lithuania.” It is also envisaged that the bank’s board will be responsible for establishing “a procedure for calculating the official rate of the litas.”
These provisions run counter to the Law on Litas Credibility, which provides that the anchor currency and the official rate of the litas are established by the Bank of Lithuania with the consent of the Government of Lithuania. The Law on Litas Credibility defines conditions and procedures for changing the anchor currency and/or the official exchange rate of the litas. If the Law on the Bank of Lithuania is deprived, as it is proposed in the bill, of a clause stating that this law is valid only as long as it does not contradict the Law on Litas Credibility, this will create a dangerous legal collision. More importantly, the proposed functions are unacceptable with respect to the currency board principles that are enshrined in the Law on Litas Credibility and require transparency and stability of the system.
If the aim is to increase the Bank of Lithuania’s independence of the government and to confer on the Bank of Lithuania exclusive powers to establish the anchor currency and/or the official exchange rate of the litas, the law should be amended in this direction. However, it is important to ensure the continuity of the currency board policy. To that end, the law should prevent changing the rate of the litas before or after the re-pegging, reducing the reserve backing, regulating the litas exchange rate and switching to interventionist central banking policy. It is therefore necessary to change the provisions of the bill allowing the Bank of Lithuania “to establish a system for regulating the rate of the litas and to announce the official rate of the litas” and allowing the bank’s board “to establish a procedure for calculating the official rate of the litas.”
In order to ensure adherence to the currency board principles, the Bank of Lithuania should not be assigned the function of “formulating and implementing monetary policy.” With a currency board in effect, this task is not only redundant but also detrimental. It should be noted that at present monetary policy is limited to administering a mandatory reserve requirement. If it were expanded, interventions would inevitably entail negative consequences. In addition to bringing instability to the market and injuring market participants, they would pose a risk of losses to the Bank of Lithuania and, consequently, the state.
The definition of the functions of the Bank of Lithuania as proposed by LFMI would not contradict the European Union agreement because the statutes of the European central banking system and the Bank of Europe define acceptable, but not mandatory functions of central banks. It should be pointed out that the statute prohibits national central banks from lending money to the government, while allowing them to provide loans to credit institutions and other market participants provided the loans are properly secured. These two provisions suggest that loans extended by the Bank of Lithuania should not be secured with state guarantees.
The clause of the bill on the management, use and control of foreign currency reserves of the Bank of Lithuania calls for special attention. The provisions of the Law on Litas Credibility defining the purpose of foreign currency reserves – backing of the amount of litas in circulation – should unconditionally remain in effect. In order to avoid legal collisions, it would be reasonable to include the same clause in the Law on the Bank of Lithuania, stating that foreign currency reserves must not be used for any other purposes.
