13.4 Central Bank Independence #Notebook
In principle, Central Banks are independent of the dictates of government, the freedom to conduct monetary policies. And by experiences, as a country’s central bank becomes more independent, its average inflation rate drops. Many Latin American and African countries had very high rates of inflation when their central banks were ruled by dictators.
If a central bank has control of its own budget, as the Fed and ECB do, then the bank is quite independent because it is beholden to no one.
The Fed is slightly less independent than the ECB because its existence is not constitutionally guaranteed. Congress could change or abolish the Fed by passing a law or it could override his veto. The ECB was formed by an international treaty, any changes to which must be ratified by all the signatories.
The Bank of Canada’s independence is limited by the Bank Act of 1967 made the government ultimately responsible for Canada’s monetary policy.
Central bankers are tougher on inflation than governments, politicians, or the general populace because they represent bank, business, and creditor interests, all of which are hurt if prices rise quickly and unexpectedly.
Businesses tend to dislike inflation because it increases uncertainty and makes long-term planning difficult.
Many households are net debtors, they owe money to some financial institutions. Inflation will decrease the real burden of their debts.
Politicians also tend to stand on the side of higher rather than lower inflation since they always writing checks to win their votes. In addition, increasing the money supply quickly or lowering the interest rate, can stimulate a short burst of economic growth that will make people happier and more willing to give returns.
After all, should everything be democratic? Would you want the armed forces run by majority vote?
Another knock against independent central banks is that they are not very transparent. The Fed has long been infamous for its secrecy.
Reference
Wright, R.E. & Quadrini, V. (2009). Money and Banking. Saylor Foundation. Licensed under Creative Commons Attribution-NonCommercial-ShareAlike CC BY-NC-SA 3.0 license.
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