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Central Bank Independence, Democracy, and Dollarization

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Abstract

Is there a fundamental conflict between insulating monetary policy from popular pressures, seen as essential to sound monetary policy, and making policy responsive to the popular will, seen as fundamental to democracy? We argue that strongly independent monetary policy is not inconsistent with democratic control of policymaking, once one realizes that a key feature of democratic policymaking is the decision to remove some decisions from “day-to-day” political pressures. This is the essence of "constitutionalism," central to the functioning of democracy, by which certain decisions are made difficult to reverse. It is further argued that a conflict between popular sovereignty and policymaker independence is not unique to monetary policy, but actually characterizes most policymaking in a democracy, with institutions designed to insulate policymaking from popular pressures. A constitutional perspective implies that extreme forms of commitment, such as a dollarization, are similarly consistent with democracy. One argument for such constraints on monetary policy (as opposed to fiscal policy, for example) is agreement on what good monetary policy means.

Suggested Citation

  • Allan Drazen, 2002. "Central Bank Independence, Democracy, and Dollarization," Journal of Applied Economics, Universidad del CEMA, vol. 5, pages 1-17, May.
  • Handle: RePEc:cem:jaecon:v:5:y:2002:n:1:p:1-17
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    File URL: http://www.cema.edu.ar/publicaciones/download/volume5/drazen.pdf
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    References listed on IDEAS

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    1. Poterba, James M, 1996. "Budget Institutions and Fiscal Policy in the U.S. States," American Economic Review, American Economic Association, vol. 86(2), pages 395-400, May.
    2. Jon Faust, 1992. "Whom can we trust to run the Fed? Theoretical support for the founders' views," International Finance Discussion Papers 429, Board of Governors of the Federal Reserve System (U.S.).
    3. Faust, Jon, 1996. "Whom can we trust to run the Fed? Theoretical support for the founders' views," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 267-283, April.
    4. von Hagen, Jurgen, 1991. "A note on the empirical effectiveness of formal fiscal restraints," Journal of Public Economics, Elsevier, vol. 44(2), pages 199-210, March.
    5. George Kopits, 2001. "Fiscal Rules; Useful Policy Framework or Unnecessary Ornament?," IMF Working Papers 01/145, International Monetary Fund.
    6. Guy Debelle & Stanley Fischer, 1994. "How independent should a central bank be?," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, vol. 38, pages 195-225.
    7. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, January.
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    Cited by:

    1. Alesina, Alberto & Stella, Andrea, 2010. "The Politics of Monetary Policy," Handbook of Monetary Economics,in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 18, pages 1001-1054 Elsevier.
    2. William C. Gruben & Mark A. Wynne & Carlos E.J.M. Zarazaga, 2001. "Dollarization and monetary unions: implementation guidelines," Center for Latin America Working Papers 0201, Federal Reserve Bank of Dallas.

    More about this item

    Keywords

    central bank independence; constitutional democracy; democratic control;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • H62 - Public Economics - - National Budget, Deficit, and Debt - - - Deficit; Surplus

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