Central Bank Independence and Monetary Policy Making Institutions: Past, Present, and Future

In the past, central banks were expected—by law, custom, or both—to use their policy instruments to attain a multitude of objectives, such as high levels of growth and employment, provision of funds to the government, and resolution of balance-of-payment problems. Today central banks’ legal and actual independence is substantially higher than it was twenty years ago, and price stability has become their primary objective. The paper reviews the institutional changes that occurred over the last two decades in the area of central bank autonomy and related monetary policymaking institutions around the world, providing an overview of accumulated empirical evidence on the relation between central bank independence and macroeconomic performance. Lessons from inflation stabilization are considered in conjunction with central bank independence within the broader context of choice of nominal anchor. The last part considers future challenges facing independent central banks in an era of price stability. Once inflation has been conquered, the bank is naturally expected to devote more attention to the stabilization of the output gap. Risks associated with such a flexible inflation-targeting regime are examined, along with issues of accountability and transparency, which become more important in the new regime. The paper also reviews the tradeoffs between democratic accountability and central bank autonomy that arise in the context of distribution of central bank profits (or losses) between the central bank and the government and the choice of central bank capital.