Central Bank independence: Low inflation at no cost? A numerical simulations exercise
The independent nature of the Central Bank is often associated with achieving low and stable inflation. Further to that the merits of independence are stretched to achieving low(er) output variability when compared to a government run monetary policy. In this paper we use the Alesina and Alesina and Gatti model to examine how often an Independent Central Bank can achieve an improvement on both counts. To do that we run numerical simulations where we change the ex ante probability of elections (and hence the degree of electoral uncertainty) with a view to determining how the private sector's perceptions affect the level of output variability. Our conclusions agree with the Alesina and Gatti assertion that there will exist occasions that both political parties will consent to the running of monetary policy by an independent institution but that is the least often occurred outcome. On theoretical grounds therefore, the trade-off between inflation and output variability (à la Rogoff) is still a valid one.
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