Abstract:

In the aftermath of the global financial crisis, countries around the world have dramatically expanded the objectives and powers of central banks beyond their traditional inflation targets and policy rates. But as these unelected, technocratic, institutions become increasingly powerful, the pre-crisis academic consensus around central bank independence – put crudely, ‘the more, the better’ – has become inadequate. We show that operational independence of central banks – the ability to choose an instrument to achieve inflation goals - has been associated with significant improvements in price stability. But, in advanced economies at least, political independence – the absence of any possibility for politicians to influence central bank goals or personnel – is not correlated with inflationary outcomes. In light of this distinction between political and operational independence, this paper then evaluates the new powers that central banks have taken on over the last few years, focusing on advanced economies. The framework we develop examines how to maximize the benefits of locating new powers inside the central bank, while minimizing potential conflicts with monetary policy and limiting political threats to the legitimacy of central banks’ operational independence.