Question

4. What does “central bank independence” mean? Write an essay summarizing arguments that favor central bank independence.

Answer 1

When the Central Bank has a freedom to make policies and there is no influence either direct or indirect of government or political leaders in the conduct of policy. Inflation is one of the key concern of every economy and one of most prominent determinant of the inflation is the relation between the government and the central bank of the economy. If central bank has a power to adjust its market tools freely to control macroeconomic issues like inflation, money supply, unemployment etc. then it is considered as independent. Almost every economy’s central bank tolerates political pressures. To quantity the independence of central bank authorities have to allow for central bank relations with the macroeconomic variables like inflation and interest rates. Empirical studies shows that it is better if central bank work independently to run the economy smoothly. Economies which gives more independence to the central bank remains more stable during the period of financial crisis or economic recessions than the economies which gives less freedom. Political interference like printing more money can create alarming situations in the economy and it can lead to collapse of the economy. The German central bank is considered as the most independent central bank and Japan’s considered as a least independent bank. Therefore some critiques say that central bank is not that necessary for the economy to run smoothly.