“Discuss the advantages and disadvantages of an independent central bank”

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                Domestic and International Finance

“Discuss the advantages and disadvantages of an independent central bank”

The case for the independent central bank is becoming increasingly accepted. When the first central banks were set up, their main objectives were to print money, and to ensure that this money was delivered to their appropriate destinations. Now however, the duties of the central bank have changed. Central banks are now subject to a much wider economic usage, amongst other policy objectives central banks are used for the reduction of inflation, and unemployment, as well as stabilizing the economic system.

To understand the disadvantages and advantages of an independent central bank, we must first look at the motivations of the central bank. The theory of bureaucratic behavior suggests that the central banks acts in order to maxamise its own welfare, just as a consumer seeks to maxamise utility.  Central banks welfare arises from its “power and prestige” (Mishkin). Thus we must remember, that according to this theory, when looking at the actions of the central bank, that it is acting in order to maintain and increase its power and prestige.

Being independent of Government control poses a number of issues for economic debate. By being given freedom from government control, the independent central bank has full control over domestic, or in the case of the European Central Bank, member nations monetary policy, consequently commanding the interest rates and the money supply of an economy.

By independent central bank I must stress this is independent in operational terms only. The targets are set politically; the bank chooses the best means to achieve the target.

Here I consider arguments for the independent central bank, using the European Central Bank as my chosen example.

In the short term, there is a direct trade off between unemployment and expected inflation. That is, if inflation is higher than economic agents expect, and then the price rises they see will appear to be real increases in value. When production becomes more valuable firms consequently produce more, leading to lower unemployment due to expansion and higher output in the economy.

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Another advantageous point to not allowing Government control over the ECB is that there are no politicians manipulating the economy in their favor. As it would be apparent the most popular politician is one of who brings about low unemployment and high output. Consequently politicians may wish influence the central banks decisions regarding interest rates at strategic times, such as re-election in order to make the economy seem as though it is favorable, these policies turnout to be short term and ultimately reflationary. However “even if the Government does not pursue secret inflationary policies, inflationary expectations will reflect the ...

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