The Monetary Phoenix: Central Bank Independence from the Great Inflation to the Great Recession

Abstract

This paper analyzes the pillar of the modern central bank governance – independence – offering three contributions. After a systematic review of the economics of central bank independence, a principal agent model is used to design a political economy framework, which explains how the politicians can shape the central bank governance in addressing macroeconomic shocks, taking into account both the wishes of the citizens and their own personal interests. The framework is used to interpret the evolution of the central bank independence from the Great Inflation and during the Great Moderation – i.e. from the seventies to the first decade of the twenty-first century – and then to discuss how it can be shaken by the recent reforms of the central bank settings activated by the Great Recession, which are increasing the central bank involvement in banking supervision.