Central Bank Independence in a Changing Environment

Abstract

We reconsider central bank independence and present an updated model suitable for the new economic environment. In the 1990s, the significance of the central bank’s independence was widely recognized. Economic theory justified assigning monetary policy to a conservative central bank to control inflation and a large number of central banks adopted inflation targeting supported by the idea of instrument independence. The situation has changed dramatically in the twenty-first century, as inflation has been replaced by deflation. Since the global financial crisis (GFC), government debt has mounted. Because such a situation was not fully considered in the 1990s, we must re-examine central bank independence. I believe that central bank independence is still important in the current situation. By utilizing its expertise and non-political position, a central bank can play a role in leading economic policy in the right direction. Thus, an alternative model (the constitutional model), where the central bank’s independence is situated within the constitutional structure, should be proposed. A central bank acts as a check on the government’s economic policies under the principle of separation of powers. After the GFC, central banks have become responsible for financial stability, public debt management, and monetary policy. Thus, we need to consider the degree of independence they enjoy in their operations, besides monetary policy. Finally, I stress that central banks should change their stance from passive to active independence. It seems that central banks have tended to avoid political conflicts so far. However, as an independent power within the government, a central bank is expected to be more active in checking the government’s policies. By creating sound tension, governments can frame better policies to overcome the current economic difficulties. The independence of central banks requires public understanding. In connection with this issue, Appendix A discusses the issues of democracy and populism from the perspective of the culture of central banks. Appendix B discusses the transition of the Bank of Japan law from the perspective of the historical mission of the developmental stage of the national economy.KeywordsCentral Bank IndependenceInflation TargetingConstitutional FrameworkSeparation of PowersUnconventional Monetary PolicyFiscal DominanceFinancial StabilityCulture of Central BankHistory of Central Banks