On Central Bank Independence and the Stability of Policy Targets

Abstract

It is argued that impediments to the establishment of an independent central bank arise in the presence of unstable policy targets. Changing policy targets may occur with an office‐motivated policymaker. This differs from politico‐economic models where targets change depending on the partisanship of the politicians in office. In the model the principal faces a tradeoff between the credibility benefits of an independent central bank and the flexibility to pursue shifts in his policy targets allowed by a regime of policy discretion. An empirical section addresses the issue of the correlation between central bank independence and the stability of policy targets.