Question

Explain the pros and cons of the independence of a central bank. Should the Federal Reserve be independent from the United States government? Why or why not?

Answer 1

Solution

The central banks should be independent from the Federal / Central Govt. of any country due to many reasons that include transparency,improved efficiency etc.,

The Pros

1.Business Cycle - When the central banks are independent they work impartially towards the betterment of their country's economy.They adopt to different policies (ex: interest rates,repo rates,slr,etc.,) depending on the business cycle the economy is experiencing.

2.Inflation - If the Central banks are working independently,they will have the ability to frame and execute the monetary policy (the method of controlling the money supply in the economy).If this task is in control of the central govt. it will not execute it properly.Govt. means politicians.Politicians take only populist measures but will not take the strict measures even if they are needed for the betterment of the economy.

3.Spending - If the govt. is given the power to operate the central bank,it will increase it's spending and does not care about the rationality behind it in most of the cases.Central banks operating independently and will serve as a proper regulatory body overseeing a number of stakeholders of the financial system in the economy.

Ex: If the Govt.becomes the regulator of the banks then it will encourage the banks to lend aggressively to the economy in case if it's promise in its political manifesto is to provide easy loans.In this process the banks suffer.

4.Stability - The governments change over definite time period. If the govt's are given the control,the financial policies will get affected as different Govt's have different policies.

Cons

1.The central banks are too much secretive - Since many times their policies are unexpected,the majority of the population (mainly the uneducated ones) feel cheated,treating the central bank as a kind of dictator.

2.The common people have a perception that the central bank is partial towards the bigger stakeholders in the financial system like banks,etc.

3.If the central bank operates independently,it does not have proper connect with all the sections of the society.Even now a days,although the central bank makes sure that it consults almost all the sections / stakeholders in the society in the process of drafting an economic policy,the society still feels that not every section of the society is adequately consulted while drafting the policy and so that the central bank is indifferent to them.

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