Here's one I missed from earlier in the week
One of the strengths of price theory is that it teaches you to think about problems in terms of constrained maximization, no matter the context. Yes, price theory often involves markets, but it can also be used to think about institutions, or the “rule of the game” in society. Price theory is fundamentally about costs and choices. Non-market activity isn’t immune from that. Neither is the design of institutions.
CB independence recap
The discourse about central bank independence is largely a response to what many perceive as political pressure being put on the Federal Reserve by the Trump administration to lower interest rates.
This is sort of wrong and silly. The Myth of Independence, by Sarah Binder and Mark Spindel (the later of whom I spent some time with at AIER a few years back) is the comprehensive historical account here. FIAT CENTRAL BANKS CAN NEVER BE FULLY INDEPENDENT FROM THEIR EXECUTIVE POWER OWNERS
We need to think carefully about how we are defining independence. We also need to keep in mind that decisions have tradeoffs. Sure, independence has benefits, but what are the costs? How do we assess the benefits and the costs, and what are the implications for independence?
Benefit: negatives ones, where politicians can't direct the CB to make short-term benefits for elected officials (= the political business cycle); or monetize the debt:
For example, increasing the money supply prior to the election might cause a short-term boost to economic activity and improve the politician’s election prospects. However, in the longer-term, this doesn’t make the public better off because the increase in the money supply will simply lead to a higher price level. [...] if politicians know that they can force the central bank to monetize the debt, this effectively relaxes the government’s budget constraint.
"The benefit of central bank independence is that it removes politicians from the decision-making process."
Cost: CB officials aren't accountable to anybody... "Even policymakers with the best of intentions might produce bad outcomes."
although the benefits of central bank independence are pretty obvious, there are costs as well. There is a tradeoff between independence and accountability. The design of a central bank must take this tradeoff into account.
Shortly after Alesina and Summers published their paper, Guy Debelle and Stanley Fischer wrote their own paper that addressed the tension between independence and accountability. They separated out three types of independence.
- goal independence (NO)
- political independence (NO)
- instrument independence (YES!)
Only instrument independence matters for inflation, say Guy Debelle and Stanley Fischer's influential 1994 paper ("How independent should a central bank be?")
Another strange observed result about independence is that...
if you look at the data from the early 2000s, you see that many central banks in developed countries converged on low inflation rates despite there being substantial variation in the index measuring central bank independence. This is puzzling if you think central bank independence is important.
They dig a little deeper and differentiate between what they call political independence (the inability of politicians to influence goals and personnel) and operational independence. What they find is that operational independence has a negative and statistically significant relationship with inflation. They find no evidence that political independence matters.
Central banks, including and especially the (entrepreneurial) Fed, can come up with new instruments and programs as they see fit... they're not politically independent in some meaningful sense (tho, to say that a Fed official, say Jerome Powell, is beholden to the president or party-controlled Senate that confirmed him, is farfetched...).
I do not think this is trivial. I think that we need to be precise about how we discuss central bank independence. Holding up independence as a particular ideal without properly defining what we mean necessarily pushes accountability to the background. Accountability is important. Throughout their short history, central banks have been known to make mistakes because they have become wedded to a particular ideology or a particular macroeconomic theory. These have typically been costly mistakes.