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Central bank governance, society and politicians: the tale of independence

from Part I - THE CONTRIBUTION OF ACCOUNTABILITY, INDEPENDENCE AND ECONOMIC THEORY TO RESPONSIVE-AND-RESPONSIBLE FINANCIAL REGULATION

Published online by Cambridge University Press:  26 November 2017

Donato Masciandaro
Affiliation:
Bocconi University
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Summary

In the modern analysis of monetary policy central bank governance plays a fundamental role. This chapter analyses a pillar of central bank governance – namely independence – and offers 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 that explains how politicians can shape 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 monetary independence during the Great Moderation – from the eighties to the first decade of the twenty-first century – and then to discuss how it can be shaken by the recent reforms of central bank settings triggered by the global financial crisis.

INTRODUCTION

The history of central banks is rich in modifications to their role and functions. Over the last thirty years – before the 2008 crisis – the mandate of central banks has been progressively narrowed. In a large number of countries the central bank mandate has focused on the area of monetary policy and zoomed on the goal of price stability. This narrowing of the mandate has been accompanied by modifications to the bank's governance arrangements. The pillar of central bank governance was identified by increasing the degree of independence.

By the early 2000s an increasing number of countries had adopted a well-defined system of central bank governance: the independent agency becomes increasingly specialised in achieving the monetary policy goals, and consequently its traditional responsibilities in pursuing the financial stability became progressively less important. But now that the crisis is posing new challenges to the modern central banking models, where monetary policy is conducted by an independent central bank which follows an interest rate rule-based approach to stabilise inflation and output gaps. A significant number of reforms are taking place concerning in particular the central bank's role in the structure of supervision.

In 2010, the US legislature passed the Dodd-Frank Act, rethinking the role of the Fed as part of the reshaping of financial supervision. Even though during the discussion of the bill US lawmakers debated the possibility of restricting some of the Fed's regulatory powers, as well as increasing political control over the central bank, the Dodd-Frank Act actually ended up increasing the responsibilities of the Fed as a prudential supervisor.

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