Central Bank Independence: Reconsidering Independence

By: Peter Ort The Quinnipiac University Economics Research Team

Photo credits: José Matute on Unsplash

This is the second article in our four-part series on Central Bank Independence (CBI) and focuses on the reconsideration of CBI, where the central bank can make decisions without influence from outside sources.

During the end of the Gilded Age in the United States, bank runs started to become increasingly common, and as a result, the U.S. Federal Reserve was founded in 1913 to be the “lender of last resort.” As time went on, however, it began to operate more and more on other promises, such as its “dual mandate,” where it aims to promote both maximum employment and stable prices. Unfortunately, none of these promises ever held in the long run, and central banks began to seek government-guided monetary policy to try to regain the trust of the public. By the 1980s, it was popular to have an “activist” monetary policy, where the Fed would have its hands in as many parts of the economy as it could to try to match its promises.

However, with inconsistent success and the emergence of inflation targeting, central banks began to follow more price-based nominal anchors as a means for monetary policy. A nominal anchor is simply a target to anchor monetary policy upon. It could take the form of a price-based anchor, such as keeping the price of gold constant (the gold standard) or keeping the inflation rate constant (inflation targeting). Alternatively, there could be a quantity-based anchor, such as keeping the money supply constant. Nowadays, monetary policy has amounted to inflation targeting and a “breathing” money supply, where the Fed is constantly expanding and contracting the money supply according to the current economic need.

But despite monetary policy becoming more optimized, central banks have certainly made mistakes that have cost them trust from both the people and the government. This has resulted in governments attempting to control the central bank to some degree, whether it is changing the nominal anchor, the way they pursue the nominal anchor, or changing personnel entirely. CBI lies in not only the government but also any other outside source (be it banks or firms) having a lack of influence in the decisions of the central bank.

Evidently, we see across the past century that CBI leads to more economically efficient outcomes, as a government administration may try to change central bank goals so that there is economic success in the short run for that administration, which usually is not good for the rest of the country. When central banks are left to their own decisions, we are left with a better chance at handling shocks and maintaining long-run economic growth.

For the previous article on inflation targeting and further context, click this link here.

Source:

Du Plessis S, Freytag A, van Lill D. Reconsidering Central Bank Independence. Cambridge

University Press; 2024.