Central Bank Independence

Key Takeaways

  • Central bank independence is a measure of how free from government influence central bankers are. Independence increases as a central bank controls its own budget; it cannot be destroyed or modified by mere legislation (or, worse, executive fiat), and it is enhanced when central banks are composed of people serving long, nonrenewable terms. Independence is important because researchers have found that the more independent a central bank is, the lower the inflation it allows without injuring growth and employment goals.
  • When unanticipated, inflation redistributes resources from net creditors to net debtors, creates uncertainty, and raises nominal interest rates, hurting economic growth.
  • Independent central bankers represent bank, business, and net creditor interests that are hurt by high levels of inflation. Elected officials represent voters, many of whom are net debtors, and hence beneficiaries of debt-eroding inflationary measures.
  • They also know that well-timed monetary stimulus can help them obtain re-election by inducing economic growth in the months leading up to the election. The inflation that follows will bring some pain, but there will be time for correction before the next election. Governments where officials are not elected, as in dictatorships, often have difficulty collecting taxes, so they use the central bank as a source of revenue, simply printing money (creating bank deposits) to make payments. High levels of inflation act as a sort of currency tax, a tax on cash balances that lose some of their purchasing power each day.