Independent Central Banks and Inflation

A number of prominent economists have signed a petition calling for Congress and the Executive Branch to reaffirm their support for and defend the independence of the Federal Reserve System."  The petition is disingenuous. 

The petition argues that "central bank independence has been shown to be essential for controlling inflation."  "Essential," is a big exaggeration.  There is evidence that more independent central banks are better at controlling inflation (e.g. Alesina and Summers 1993).  Consider, however, New Zealand's central bank; it has been very successful at reducing inflation but in some ways it is one of the least independent central banks in the world precisely because (unlike in the U.S.) the governor can be fired if inflation moves outside of a target region.

Furthermore, the petition says that central bank decisions should not be "politicized."  Again,this is disingenuous.  Why are more independent central banks better at fighting inflation than less independent central banks?  There is nothing magical about independence that makes for low-inflation.  Suppose we pick someone at random and give them complete power over monetary policy.  Such a central banker would be very independent but I wouldn't count on this policy resulting in much in the way of systematically lower inflation.

The primary reason that independent central banks are better at controlling inflation is that absent direct political control the default selection mechanism favors bankers, i.e. lenders, people whose interests make them more favorable towards lower inflation.

Thus, independence is a political decision that favors lenders in the decisions of monetary policy.  Now, depending on the alternatives, there may be good reasons for making this choice but we should not fool ourselves into thinking that we have depoliticized money.  We should not be surprised, for example, that "independent" central banks tend to make lender of last resort decisions that protect banks and bankers.

Addendum: See also Robert Higgs on the petition and Arnold Kling offers cogent comments on the closely related issue of whether the Fed should be "audited," whatever that means.


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