Blog: Central banks play important role in building social capital – OMFIF

The contribution of central banks to social capital can be expressed through words like trust, stability, predictability, confidence and credibility. Citizens value the commitment of central banks to these values, as they constitute a key element of the implicit social contract between society and central banks. Social capital is based on trust, norms and values, and generates positive externalities. The functioning of the economy, and particularly that of the financial system, relies on trust and confidence and central banks have a unique role in this.

Monetary and financial stability are the key pillars of strong and sustainable growth. Episodes of inflation and financial instability contribute to an erosion of social capital. The preservation of trust in the value of the currency is the most important contribution by central banks to rebuilding social capital. As a precondition for monetary and financial stability, central banks should achieve efficiency, innovation and security in the use of payment systems, adjusting swiftly to digitalisation.

The growing multiplicity and complexity of roles played by central banks bring about more responsibilities and much higher expectations by citizens. Central banks’ responsibilities have spread in many cases to microprudential supervision, conduct supervision, supervision of insurers and the funds industry, resolution, deposit guarantee schemes, consumer protection and financial literacy. The successful achievement of all these objectives is essential for building social capital.

Financial reforms implemented over the last 15 years have been decisive for rebuilding social capital, by restoring trust in market mechanisms and institutions. The process of rebuilding social capital is not, however, complete. Urgent action is needed on completing the Basel reforms, developing a macroprudential framework for the non-banking sector and addressing emerging risks for financial stability (from digitalisation, innovation and climate change).

Financial literacy and financial inclusion initiatives promote more effective and fairer economic outcomes. Insights from behavioural economics are crucial for the design of financial regulation and consumer protection. Developing financial literacy and financial inclusion initiatives is of paramount importance to reinforce social capital.

Accountability is very important: central banks should be able to explain why they have taken specific policy decisions and to explain their respective outcomes. The inclusion of heterogeneity in macroeconomic modelling is an essential component of central banks’ accountability, as central banks should fully understand how their actions impact the economy in aggregate and distributional terms.

Another important element of accountability is the evaluation of policy measures, based on rigorous ex post assessments. Evidence-based policies – supported by the findings of sound economic evaluations and lessons learnt, as in the framework implemented by the Basel Committee on Banking Supervision – are typically much more effective.

The existence of expectation gaps between what it is expected from central banks and what they can effectively deliver endangers social capital. Effective communication by central banks is required, with full public understanding of the objectives and the mission being the aim. Greater accountability and transparency are essential, as well as promoting proximity with society.

The degree to which central banks contribute to building social capital depends on how credible they are as institutions. This contribution is conditional on the functioning of other public authorities. The ability to deliver collectively – by governments, central banks and other public institutions – is what contributes to rebuilding social capital. The institutional framework is also an important conditioning factor. Trust in central banks can be limited or even endangered if any part of the institutional sector is not functioning properly, or if the institutional framework is not perfectly designed.

Pedro Duarte Neves is Adviser for the board of directors, Banco de Portugal.

This article is based on the summing up by Pedro Duarte Neves of the Proceedings of the Conference: Rebuilding Social Capital: the Role of Central Banks, celebrating the 175th anniversary of Banco de Portugal.

This article was published the Sustainable Policy Institute Journal, summer edition.

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