Why has the idea of enhancing the independence of a central bank gained such popularity in recent years around the globe? Do accompanying accountability arrangements matter?

The desirability of Central Bank Independence (CBI) has snowballed since (Alesina, A 1988) stated that his paper “argues tentatively” that independent Central Banks have been associated with a lower average inflation rate and “may have been responsible” for reducing politically induced volatility of monetary policy and inflation. As a result, we may be lured into the assumption that CBI was the brainchild of Alesina or Rogoff (who produced literature with similar results around the same time) and that it is a brand-new, groundbreaking concept. However, the issue of CBI is as old as central banking itself with David Ricardo arguing its benefits (or certainly the drawbacks of non-independence) in a paper written in 1824. Keynes articulated his thoughts on central bank independence while testifying to the 1913 Royal Commission into an Indian central bank. He stressed that the ideal central bank ‘would combine ultimate government responsibility with a high degree of day to-day independence for the authorities of the bank’. Clearly, as it is government legislation that created and gave powers to the central banks, there has always been a relationship between the two and they cannot be entirely distinct. Debate surrounding CBI considers the appropriate level of distinction (if any) and the potential benefits to the economy at large that such a separation would provoke. So if the theory behind the benefits of independence is almost two centuries old, then why has its popularity only soared in the last few decades?

(Goodhart, C.A.E 1994) utilises Friedman’s analysis of the Phillips Curve (1950s) to suggest that “stagflation” in the 1970s is a primary factor behind the surge towards CBI. The Phillips Curve displays the apparent inverse relationship (when the pressure of demand in an economy is low) between inflation and unemployment. Thus, Phillips suggested that the authorities were able to choose an optimal combination, or find a sufficient trade-off between the two, which is exactly what Governments attempted to do in the 50s and 60s. However, this theory was shot to pieces in the 1970s when the rate of inflation consistent with a given level of unemployment kept rising: “stagflation”. Friedman explained this by stating that the inverse relationship only ran true in the short-run. In the medium and long-run, he argued that the Phillips Curve would in fact be vertical and that there was no trade-off between inflation and unemployment. The implication of this was that those in charge could now use monetary policy as an instrument to control inflation in the medium and long term without compromising growth or employment within the same time horizon; thus enabling fiscal policy and supply side me