Central Bank Confidential
Over the past two decades, countries around the world have recognized the importance of central banks' independence. In truth, however, there are many degrees of independence, and not all nominally independent central banks operate in the same way – as a new initiative by the Bank of England demonstrates.
LONDON – In 1993, the economists Alberto Alesina and Larry Summers published a seminal paper that argued that central bank independence keeps inflation in check, with no adverse consequences for economic performance. Since then, countries around the world have made their central banks independent. None has reversed course, and any hint that governments might reassert political control over interest rates, as happened recently in India, are met with alarm in financial markets and outrage among economists.
In truth, however, there are many degrees of independence, and not all nominally independent central banks operate in the same way. Some monetary authorities, like the European Central Bank, set their own target. Others, like the Bank of England (BoE), have full instrument independence – control over short-term interest rates – but must meet an inflation target set by the government.
There are differences, too, in how central banks are organized to deliver their objectives. In New Zealand, the bank’s governor is the sole decision-maker. At the US Federal Reserve, decisions are made by the Federal Open Market Committee (FOMC), whose members – seven governors and five presidents of the Fed’s regional reserve banks – enjoy varying degrees of independence.