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CentER for Economic Research,

By Sylvester C. W. Eijffinger

Abstract

Many observers believe that countries with an independent central bank have lower levels of inflation than do countries with a central bank that comes under direct control of the government. Why would central bank independence, ceteris paribus, yield lower rates of inflation? The literature (for a survey, see also Eijffinger and De Haan, 1996) provides three answers to this question: public choice arguments, the analysis of Sargent and Wallace (1981) and arguments that are based on the time inconsistency problem of monetary policy. According to the `older ' public choice view, monetary authorities are exposed to strong political pressures to behave in accordance with the government's preferences. 1 Monetary tightening aggravates the budgetary position of government: the reduction in tax income brought about by a temporary slowdown of economic activity, possibly lower receipts from `seigniorage', and the short-run increase in the interest burden on public debt all worsen the deficit. Thus, the government may prefer `easy money. ' Indeed, some evidence exists that even the relatively independent Federal Reserve caters to the desires of the President and/or the Congress. This evidence is either based on close inspection of the contacts between the polity and the central bank (see e.g. Havrilesky, 1993,

Year: 2011
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