Central Bank Independence and Inflation

Since the work of Alesina and Summers (and other economists), more and more countries have become convinced of the virtues of having an independent central bank. For example, when the Labour Party came to power in Britain during the 1990s, one of their first acts was to make the Bank of England more independent. This was particularly striking because the Labour Party is a center-left political party, yet independent central banks tend to be conservative, focusing primarily on inflation and not worrying so much about employment and output. Events in Argentina also attest to the value of an independent central bank. In 2003, the Congress in Argentina passed an act stating,

The Argentine Central Bank is a National State self-governed institution, whose primary and fundamental mission is to preserve the value of the Argentine currency. When formulating and implementing the monetary and financial policy, it is not subject to the orders, guidelines or instructions of the National Executive branch of government. [2]

Don't use plagiarized sources. Get Your Custom Essay on
 Central Bank Independence and Inflation
Just from $13/Page
Order Essay

There are two key elements in this act. First, the stated goal of the Central Bank of Argentina is to preserve the value of the currency. There is no mention of pursuing full employment, just a version of price stability. Second, the central bank is to be independent of the executive branch of the government. Inflation Targeting Under a policy regime called inflation targeting, some central banks use their tools to set the inflation rate as close as possible to a target. Just as we know that a monetary authority cannot literally control interest rates, we know it cannot literally set the inflation rate either. Rather, it can use the policy tools at its disposal to influence the economy in an attempt to reach the target inflation rate. In its simplest form, the target is some publically announced inflation rate—say, 3 percent. If the monetary authority thinks the inflation rate is likely to be higher than 3 percent for the year, it adopts contractionary monetary policy to reduce the inflation rate. If it thinks that the inflation rate is likely to be lower than the target, it adopts an expansionary policy.