Central Bank Independence – To be or not to be

Central Banks are crucial to the economic well-being of countries due to the various fiscal and monetary policies that are being carefully implemented to achieve the goal of a sustained economic growth and development in the long run. However, a widely discussed issue related to central banks would be the independence of it — that is, if it should be separate from the government or if it should operate hand-in-hand. As such, IPEBP presents the arguments for and against the independence of Central Banks.

Arguments FOR Independence:

The Economic Argument for independence of central banks is based on the fear that the ruling government and parliament will be tempted to succumb to monetary expansions to meet their financial need, therefore neglecting the risks and detriments of fiscal inflation. Basically, this means that in order to “fix” monetary problems in the country, the government will be more inclined towards printing more money to increase the amount of money in the country. This however leads to a detrimental problem known as inflation where the goods and services are unnecessarily priced at high rates. The worth of the currency is also then at risk where a lot of money can barely buy necessities. Often this leads to a thriving black market situation with the illegal sales of almost anything and everything money can buy.

The Political Argument for central bank independence on the other hand, states that an Independent bank, operating without regards to day-to-day business of politics, can be a guarantor of continuous stabilization policy. Politicians tend to focus on the near future and they are subject to the pressure of public opinion and special interest groups and tend to exhibit an inflationary bias when elections approach. However so, IPEBP also notes that political authorities may have an interest in maintaining central bank independence as it allows them to blame the central bank for unpopular policies.

Arguments AGAINST Independence:

Democratic Legitimacy happens to be the dominant argument against central bank independence which argues that  an institution which is free from direct effect of political control lacks democratic legitimacy. By democratic legitimacy, there are concerns that arise over the the electing process within the organisation and operations of the central bank. The question of how the head of the bank is being elected or if he is even being elected at all and if so, is it being done democratically are all part of the spectrum of democratic legitimacy.

The need for a Consistent Economic Policy is the second major objection towards central bank independence. With a central bank that is operational entirely on its own without any supervision or input from the government runs a risk of hindering the maintenance of a consistent economic policy. As a result, there can be an uncoordinated monetary and fiscal policy which can lead to undesirable outcomes for the country.

Incentives and Bureaucratic Behavior are the crux of the “Bureaucratic theory” which suggest that the central bank will further its own benefit and prestige instead of the general welfare. This hence suggests for supervision of central banks and that they should not be left to be entirely independent.

Ultimately, the ideal situation then seems to be that the central bank should not be operated entirely independent. At the same time, these institutions should uphold transparency and openness in their operations and policy making processes in a bid to dismiss qualms about its democratic legitimacy and its true intentions. Also, while political influence can sway the decisions of central banks, political input is critical as well so long as it is of a fruitful and objective manner.

 

 

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