Question

Discuss the advantages and disadvantages of an independent central bank?

Answer 1

Answer) Advantages

Having an apolitical central bank has many benefits. Few of them have been summarized below.

Political Cycle vs. Business Cycle: Politicians all over the world are only worried about staying in power. They will do whatever it takes as long as they can remain in control. Hence, it can be said that the actions of the politicians are regulated by political cycles. They become incredibly generous and adjusting during the pre-election years.

The business, on the other hand, operates based on business cycles. It is not essential that periods of boom and bust will occur simultaneously with the political cycles. Also, if they do, politicians may have a clash of interest. For example, if there is too much inflation during an election year, politicians might simply ignore the essential but undesirable decision of executing rate hikes. Hence, it is likely that the politicians will end up endangering the entire economy for cheap gains. This is the purpose why central banks need to be independent. They can take strong decisions regardless of the election cycle. The economy and elections are not generally correlated. Hence, it is important that the decisions considering the economy be taken alone.

Inflation: Controlling inflation is the fundamental goal of any central bank. In order to do so, they need to regulate the money disbursed by the government. If decisions regarding the economy can be taken by the government, they will take only populist decisions. For example, governments may decide to deliver free health care and retirement help even though they don’t have the financial wherewithal to enforce such decisions. The bottom line is that if the government is given supervision of the economy, they might resort to indiscriminate money printing which will eventually lead to economic fall. Hence, to avoid this, central banks have been made independent of a government administration.

Deficit Spending: Governments all over the world are fond of undertaking populist projects even though such projects are not financed by economic fundamentals. the government should not have indulged in deficit spending. Hence, it is important to keep the monetary policy independent from the government in order to conserve the financial spirit of the state.

Disadvantages

Segregating the central bank from the state has many advantages that have been summarized above. Nevertheless, there are some drawbacks as well.

Secretive: The biggest critique against the central bank is that their methods are very covert. Many times their actions are completely surprising. Many financial crises in the past have only taken place because the central bank took startling action. To curb this from occurring again, central banks need to ensure steady transitions. Their policies should not be confidential and should not upset the economy.

In Favor of Big Banks: Many critics are of the belief that all the policies created by central banks are in favour of huge banks and not in favour of ordinary people. For example, their biggest goal is to curtail inflation. Though, after the 2008 crash, they pursued a strategy of quantitative easing to save the big banks. This has proved to create more inflation.

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