Answer to Question #252127 in Macroeconomics for Biba

Question

5. In his memoirs, Alan Greenspan wrote, à ƒ ƒ ¢ € œI regret to saybthat Federal Reserve independence is not set in stone.
FOMC discretion is granted by statute and can be withdrawn by statute.à ƒ ƒ ¢ €  (The Age of Turbulence, p. 478 f.) Explain why the independence of a central bank might affect the way in which monetary policy is conducted. If a central bank is not independent, how might its monetary policies change in response to electoral
pressures? Would you recommend that a new country have an independent central bank? Explain.

Answer 1

1. Independence of the central bank helps in controlling the amount of money spent by the government. For instance, the government may decide to provide free education and healthcare though it does not have the financial capability to do so. This may result in the government resorting to indiscriminate money printing which leads to ultimate fall of the economy. Making central banks independent of government authority helps to prevent this.
2. If the central bank is not independent, this may result in enactment of irresponsible and counter efficient monetary policies. Policymakers will ever be in temptation to satisfy their monetary desires at the expense of the purchasing power of their citizens. The government will outspend its own budget constraints. The purchasing power of citizens will be diminished leading to hyperinflation.
3. I would recommend that a new country have an independent central bank. This is because research indicates that the more independent a central bank is, the lower the level of inflation it allows without injuring employment and growth goals.