The old belief was based on the notion that a central bank would measure the success of its actions by the extent to which economic activity could be raised and maintained above potential. If rational individuals already expect a certain change, they adjust their behaviour to that expectation. And that means that a monetary policy change would have no effect. In the past fifteen years, however, two important developments changed the theory and practice of central banking. First, the assumption that successful monetary policy acts by surprises and is made by a sequence of isolated steps has been the subject of thorough theoretical scrutiny and is now close to oblivion. It became clear that policy-making by surprises and isolated steps will bear no lasting effect on the economy once the public recognises the intentions that motivate the monetary authority. A monetary policy strategy made of isolated actions with the intention of boosting output above potential is bound to lose effectiveness because the short-term inflationary impact of that policy soon becomes embedded in price and wage expectations. Output and employment react in the very short-run, but in the medium term the economy suffers from a permanently higher inflation. The drive toward central bank independence provided an additional encouragement for transparency. Today an overwhelming majority of central banks across the globe is independent. The political and functional independence of central banks has been an important milestone in the way towards separating the authority to tax and spend from the power to control credit conditions.
There are numerous examples in his legacy, in being resolute in pursuing his convictions and about his effective management of the interface with the political process, given that politics is an important part of the ecosystem of institution building. He achieved this without compromise, sustaining always the integrity of the institutions he was associated with. Institutional building therefore needs to be viewed from the broader perspective to include strengthening the institutional arrangements of how economies and financial systems can more effectively function, adding value for greater economic wellbeing. Just as we have seen that with the advances in technology, we need to change the hardware and software. So is the case for institutional building to support economic development. It will also involve changing the institutional “hardware” and the “software” Increasingly, emerging economies are in transition towards greater market orientation in which the market has become an important mechanism in generating economic growth. While market mechanisms are generally successful in achieving greater productive efficiency, it does not always result in greater allocative efficiency. As a consequence, disequilibrium conditions and market failures may not only be detrimental to social welfare, but may also weigh on an economy’s growth and development prospects. Strong institutions that provide regulatory and supervisory oversight are therefore necessary, in order to facilitate the effective functioning of markets while having the institutional capability to manage disruptions.