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7 - The Complex Relationship between Central Bank Independence and Inflation

Published online by Cambridge University Press:  06 December 2010

Pierre L. Siklos
Affiliation:
Wilfrid Laurier University, Ontario
Martin T. Bohl
Affiliation:
Westfälische Wilhelms-Universität Münster, Germany
Mark E. Wohar
Affiliation:
University of Nebraska, Omaha
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Summary

Abstract

In this survey, we present a number of arguments that question some aspects of the conventional view of central bank independence (CBI). We argue that CBI is neither necessary nor sufficient for reaching monetary stability. First, CBI is just one potentially useful monetary policy design instrument among several. Second, while the relevant economic theories focus on the aspect of goal independence, in practice most central banks tend to be only instrument independent. Third, CBI should not be treated as an exogenous variable, but attention should be devoted to the question of why central banks are made independent. CBI is chosen by countries under specific circumstances, which are related to their legal, political, and economic systems. Fourth, in a number of empirical studies, researchers found CBI to be correlated with low inflation rates. By taking the endogeneity of CBI into account, however, there remains little reason to believe the correlation between CBI and low inflation tells us anything about causality.

Introduction

Central bank independence has become one of the central concepts in monetary theory and policy. Most economists agree that CBI is desirable because it helps to reach the long-term goal of price stability. Although one might think about alternative mechanisms to reach low rates of inflation, CBI is the one most-often recommended. The idea has also found confirmation in the fact that an increasing number of countries in all regions of the world made their central banks independent in the last 20 years (Arnone et al. 2007; Cukierman 2007).

Type
Chapter
Information
Challenges in Central Banking
The Current Institutional Environment and Forces Affecting Monetary Policy
, pp. 179 - 217
Publisher: Cambridge University Press
Print publication year: 2010

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