Question

5. a) What are the principal arguments for a country to have an “independent” central bank? (b) In Canada, how does a government approved low inflation mandate for the Bank of Canada help ensure the independence of the Bank of Canada? How does this low inflation mandate impose a constraint on the Government of Canada’s ability to run large and persistent budget deficits?

Answer 1

5.
A.
There are different principal arguments regarding the formation of independent central bank. The firs argument is that it helps the bank to form a policy that is free from political biases. The second argument is that a bank can make long term policy for the country that can drive the different part of the country in one direction. As a result, stable price and economic growth can be achieved.
B.
If a government approves the low inflation mandate, then it should be compared with the policy recommendations of the bank of Canada. Here, the policy recommendation of the bank of Canada to make low inflation rate and followed by the government will justify the independence of the central bank. If government has put It as a recommendation on the bank of Canada to keep a low inflation rate, then I means that government is indirectly affecting the decision making process of the bank of Canada. Hence a government approving the decision of bank of Canada to maintain lower inflation rates , vindicates the importance of an independent central bank.
Since government spending and maintaining large budget deficit will create a higher inflation rate . As a result, the bank has to take austerity measures to reduce the government spending and deficit . Then low inflation mandate will be realized . So, the low inflation mandate will work as a constraint to the large government deficit .