In this essay I will investigate to what extent a Central Bank should have both goal and instrument independence followed by an examination of the possible implications this could have on the macro-economic objectives. A Central Bank has several functions; these include the issue of national currency, to act as banker to both government and private banks, and to oversee the financial system. Central Banks also administer national monetary policy, using their influence over the money supply and interest rates to implement macroeconomic policies.
The argument for a Central Bank independent of any government intervention is one that states Central Banks should be able to concentrate on the long term needs of an economy whereas political intervention may be guided by the short term needs of a government. Central Bank independence can be divided into two categories; Goal and instrument independence. Goal independence is the freedom that the Central Bank has to select the objectives of monetary policy, whether it is the target rate of unemployment, the level of GDP or low inflation etc.
Instrument independence is the freedom that the Central Bank has to pick the appropriate policies that produce a certain outcome in the economy. In the UK the inflation targets are set by the Treasury and the Bank's monetary policy committee sets interest rates to try to meet them. Thus the Bank of England does not have autonomy in choosing the inflation target and as such does not have goal independence. The Bank, however, has complete independence in making monetary policy decisions aimed at achieving the target and hence has instrument independence.
The main macroeconomic objectives are price stability, full employment, a satisfactory but sustainable rate of economic growth and keeping the balance of payments in equilibrium.
- Price Stability
Inflation is generally defined as...