Macroeconomics – Home Assignment 6 Aniket Dubey | 1901010 | Section A

Question: Make a case for or against the central bank independence by reading the
following resources in addition to the knowledge gained from the text book.

Answer: The answer to this question when making a case may not be binary, i.e. yes or no, but it's
about if the central bank's independence is increased or decreased. I agree that the independence of
the central bank is extremely important in the context of today. There are already some indicators of
central bank independence, such as the rules for appointing and dismissing central bank governors,
the central bank's ability to finance its operations without relying on government, central bank's goal
setting, monetary expansion or contraction, etc.

It was noted that the independence of the central bank is inversely proportional to inflation. This is
the same for developed countries as well as developing countries. By reducing the inflationary
period of the 1980s, the central bank has already proved its worth in. In setting goals and targeting
inflation, the central bank should continue to embrace independence. Otherwise, by reducing
unemployment, politicians tend to loosen monetary policy and increase inflation unexpectedly. In
order to combat increased inflation due to expansionary fiscal policies, central bank independence is
also necessary, a trend that has been noted in recent times. In addition, monetary policy is usually
tried on a medium-term basis, for which fiscal policymakers are not well equipped. Over the past 3
decades, central banks in most developed economies, including the US, have demonstrated their
ability to maintain the low level of inflation on an average. This is the result of their independence.

This should, however, come with greater accountability and transparency. This will help central
banks to avoid intervention by policymakers. In order to maintain this independence, central banks
also need to maintain their credibility, which has deteriorated as a result of crises in 2008 when
Lehman failed to collapse. Furthermore, for most developed and developing countries, the
complementary monetary policy with fiscal policy needs the hour.

But the central bank still faces some challenges because it is independent in its decisions. One of the
challenges facing the central banks is the ongoing political pressure. The dilemma is that due to
expansionary fiscal policies, the central bank should be responsible for financing increased fiscal
deficits. According to the CFM survey, most experts believe that the independence of the central
bank will decline due to political pressures. Increasing populism is also attacking technocratic
institutions to reduce their powers, including central banks.

Therefore, the key in the current scenario is the independence of the central bank with a high level
of accountability and transparency in its operations and setting goals.