Rogoff and Palley on central bank independence

Is independence instrumental in fighting inflation?

Thomas Palley argues that empirical evidence shows that:

• In advanced countries the inflation – independence relation has disappeared in the 2000s as shown in the figure below:
  
• Central bank independence in emerging economies does not seem to matter for inflation, though there is weak evidence it may matter in developing economies. Interestingly, for these economies, it is the participation in IMF programs that is highly significant in explaining inflation.

He concludes:

The case for central bank independence is built on an intellectual two-step. Step one argues there is a problem of inflation prone government. Step two argues independence is the solution to that problem. This paper challenges that case and shows it is based on false politics and economics. The paper argues central bank independence is a product of neoliberal economics and aims to institutionalize neoliberal interests. As regards economics, independence rests on a controversial construction of macroeconomics and also fails according to its own microeconomic logic. That failure applies to both goal independence and operational independence. It is a myth to think a government can set goals for the central bank and then leave it to the bank to impartially and neutrally operationalize those goals.  Democratic countries may still decide to implement central bank independence, but that decision is a political one with non-neutral economic and political consequences. It is a grave misrepresentation to claim independence solves a fundamental public interest economic problem, and economists make themselves accomplices by claiming it does.

Central Bank Independence: A Rigged Debate Based on False Politics and Economics
By: Thomas Palley

The relevance of central banks

The real challenge to central banks, argues Kenneth Rogoff, doesn’t come from being too powerful but instead from struggling to remain relevant. There are four reasons why this is so:

• Global inflation has been so low for so long, people have started to forget what it was like in the pre-independence era;
• Monetary paralysis at the zero lower bound on interest rates has greatly limited the effectiveness of monetary stabilization policy in normal recessions;
• The zero bound implies very limited capacity to stimulate a sluggish post-crisis economy, so that central banks would quickly be relegated to the sidelines, for better or for worse;
• There is a growing view that for advanced economies, ultra low interest rates make higher government debt a free lunch, with economic growth reliably preventing debt-to-income ratios from growing. The implication is that much higher debt can be accommodated without ever raising taxes, much less resorting to inflation, again undermining the case for having central bank independence.

Is This the Beginning of the End of Central Bank Independence?
Author: Kenneth Rogoff
From: Harvard University