Is Central Bank Independence Always a Good Thing?

Abstract

Central bank independence (CBI) solves the time inconsistency problem faced by policymakers with respect to monetary policy. However, it does not solve their underlying incentives to manipulate the economy for political gains. Unable to use monetary policy, and often limited in their ability to use fiscal spending, governments can resort to financial deregulation to generate short term economic benefits. Drawing on case studies and large-N tests, we show that governments systematically weaken financial regulations in the aftermath of CBI. The financialization of the economy and the growing political power of the financial industry could therefore be a by-product of central bank independence.