How Independent Should the Central Bank Be?

The Bank of England, UK [Photograph]. October 26 , 2017. Bigstock.

The independence of the central bank relates to the freedom of the monetary policymakers in a country. Therefore, the independence of the central bank also relates directly to the country’s economic independence. The independence of the central bank refers to both the independence from its own government and the independence from foreign influences. If the central bank in a country is independent, it can be said that that central bank is able to make policies, and produce and apply monetary strategies on its own. According to Baydur and Süslü’s opinion, ‘In contemporary monetary policy, it is generally accepted that there is a positive correlation between the independence of central bank and stable inflation’ (2008). In this article, we will examine why it is important for a country for its central bank to be independent, the independence of the central bank from its own government, and lastly, the relationship between inflation rates and the independence of the central bank, in order to determine if the independence of the central bank has positive influences on the macroeconomy of the countries.


When it comes to the meaning of the independence of the central bank, it can be simply put as the ability to do their activities without interruptions and outside influences, and to be able to be administrated by their own. Despite the idea of a fully independent central bank being very appealing, in reality, the relationship between the government and the central bank has been a very complicated one throughout history. According to Walsh (2010), the complications arise from the role of the government in appointing (and dismissing) members of the central bank governing board, the voting power (if any) of the government on the board, the degree to which the central bank is subject to budget control by the government, the extent to which the central bank must lend to the government, and whether there are clearly defined policy goals established in the central bank’s charter.


Firstly, the role of the government appointing (and possibly dismissing) members of the central bank plays a significant role on the independence of the central bank. To give an example, we will examine two countries’ approaches on this matter: USA and Turkey. In the USA, before the appointment of the president of the Federal Reserve (FED), the President of the USA nominates them publicly from months ago. However, in Turkey, in the last year, the president of the central bank was replaced two times with little notice. These examples show the fact that the government’s role of appointment and dismissing may have an effect on the independence of the central bank. Debelle and Fischer (1994), who determined the two aspects of a central bank which are 'goal independence' and 'instrument independence.' Goal independence refers to the central bank’s ability to find out the goals of policy without direct influence of the fiscal authority. Instrument independence pertains only to a central bank’s ability to freely adjust its policy tools in pursuit of the goals of monetary policy.


Lastly, the relationship between inflation rates and the independence of the central banks are a way for people to understand the importance of the independency of the central bank. Debelle and Fischer (1994) showed evidence that it is the combination of goal dependence and instrument independence that produces low average inflation, although their empirical results were weak. On the other hand, the theoretical evidences from Rogoff suggests that "Because the central bank cares more about achieving its inflation goal, the marginal cost of inflation is higher for the central bank than it would be for the government. As a consequence, equilibrium inflation is lower (1985)." On both sides of the researches, there seems to be negative correlation between the inflation rates and the independence of the central bank.


In conclusion, the issue of the independence of the central bank is closely examined with its political and legal relationship with the government. Although the relationship between the government and the central is complicated, it is vital for a country’s economy to have their central bank as independent as possible. The main ways that the government may interrupt the central bank’s independency are the following: the role of the government in appointing (and dismissing) members of the central bank governing board, the voting power (if any) of the government on the board, the degree to which the central bank is subject to budgetary control by the government, the extent to which the central bank must lend to the government, and whether there are clearly defined policy goals established in the central bank’s charter (Walsh, 2010). On the other hand, the independence of the central bank is observed by two dimensions: "the instrumental independence" and "the goal independence" (Debelle and Fisher, 1994). These two dimensions of independence are determined as the basis of the measurement of any central bank’s independence from the government.





References

  • Baydur, C. M., & Süslü, B. (2008). The Independence of The Central Bank : The Turkish Experience. İktisadi ve İdari Bilimler Dergisi, 22, (1), 1.

  • Debelle, G. and Fischer, S. (1994). How independent should a central bank be? In Goals, Guidelines and Constraints Facing Monetary Policymakers, ed. J. Fuhrer. Boston: Federal Reserve Bank of Boston.

  • Rogoff, K. (1985). The optimal commitment to an intermediate monetary target. Quarterly Journal of Economics, 100, 1169–89.

  • Walsh, C. E. (2010). Central Bank Independence. Monetary Economics, 21–26. Akıncı, M. Y. , Akıncı, G. Y. And Yılmaz Ö. (2015). The Relationship Between Central Bank Independence, Financial Freedom, And Economic Growth: A Panel ARDL Bounds Testing Approach, Central Bank Review, Vol.15 , pp 1-14.


Image Resource

  • Asiastock. (2017, October 26). The Bank of England, UK [Photograph]. Bigstock. https://www.bigstockphoto.com

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