In simple terms, the central bank is the authority that is in charge of a country’s currency, supply of money, interest rate and credit. More specifically, the central bank uses its monetary policy tools to achieve certain objectives for the benefit of the economic interests of the nation and also to consistent with the government fiscal policy. The idea of central bank can trace back to 17th century. Ever since, a number of countries, such as France, New Zealand, Spain, and the United Kingdom, enact law to make their own central banks more isolate from the government after witnessing the good practice of Germany and Switzerland. So far, the most independent central bank in term of conduction of monetary policy are the European Central Bank and Federal Reserve System in the United State.
In this paper we would discuss about three crucial characteristics that lead to the success of an independent central bank.
Conservative
There is an increasing agreement that a low and stable inflation rate referred to price stability is good for the economy. Some researches indicate that a low and stable inflation rate could help enhance the rate of economic growth.
The concept of inflation bias was initially introduced by Kydland and Prescott (1977), they predicted if monetary policy maker is guided by discretion rather than rules, there is a great chance to have time inconsistent problems which, in turn, leads to inflation bias. It is showed, in Barro-Gordon model, that a nation will attempt to lower the unemployment and stimulate output since that will make public be more in favour of government. This action is quite common especially when there is a re-election of government. Based on the Phillips curve, we can know that lower unemployment i...
... middle of paper ...
...nk Independence? A Critical Re-examination.’’European Journal of Political Economy. 18; 653-674.
Herrendorf, B., & Lockwood, B. (1997). Rogoff's" conservative" central banker restored. Journal of Money, Credit, and Banking, 476-495.
Lilic, A. (1998). Is an independent central bank a good thing? The European Journal.6(1).
Mishkin F(2000). What Should Central Banks Do? Federal Reserve Bank Of St. Louis.
Mishkin, F. S. (2004). Can central bank transparency go too far? (No. w10829). National Bureau of Economic Research.
Schwödiauer, G., Komarov, V., & Akimova, I. (2006 ). Central Bank Independence, Accountability and Transparency: The Case of Ukraine FEMM Working Paper Series, 30.
Van der Cruijsen, C. A. B. (2008). The Economic Impact of Central Bank Transparency (No. urn: nbn: nl: ui: 12-3130604). Tilburg University.
Walsh,C.(2003) Monetary Theory and Policy. MIT Press
Monetary Policy is another policy used in Keynesianism which is a list of protocols designed to regulate the economy by setting the amount of money that is in circulation and controlled interest levels. The Federal Reserve system, also known as the central banking system in the U.S., which holds control of this policy. Monetary policy has three tools used by the Federal Reserve to enforce this policy. Reserve Requirement is the first tool that determines the lowest amount of money a bank must possess and is not able to lend out. The second way to enforce monetary policy is by using the discount rate or the interest rate a bank will charge.
Eccles, George. The Politics of Banking. Salt Lake City : University of Utah Press, 1982
The Federal Reserve and Macroeconomic Factors Introduction The Federal Reserve controls the economy of the United States through a variety of tools. They use these tools to shape the monetary policy of the United States in order to promote economic growth and reduce the rate of inflation and the unemployment rate. By adjusting these tools, the Fed is able to control the amount of money in the supply. By controlling the amount of money, the Fed can affect the macro-economic indicators and steer the economy away from runaway inflation or a recession.
Metzler, Allan H. A History of the Federal Reserve, Vol I and II. University Press Books, 2002
The adaptive expectations theory assumes people form their expectations on future inflation on the basis of previous and present inflation rates and only gradually change their expectations as experience unfolds. In this theory, there is a short-run tradeoff between inflation and unemployment which does not exist in the long-run. Any attempt to reduce the unemployment rate blow the natural rate sets in motion forces which destabilize the Phillips Curve and shift it rightward.
The Federal Reserve Board uses three monetary tools that affect macroeconomics such as unemployment, inflation, and interest rates, and control the money supply; these tools are known as discount rate, reserve requirements, and open market operations. In The Economy Today Schiller 2010 states that “Monetary Policy is the use of money and credit controls to influence macroeconomic outcomes” (p.309.) It also refers to the actions assumed by the Federal Reserve Board.
Mishkin. F. C. (2009). The Financial Crisis and the Federal Reserve. NBER Macroeconomics Annual, 24, 495-508
Before we begin our investigation, it is imperative that we understand the historical role of the central bank in the United States. Examining the traditional motives of this institution over time will help the reader observe a direct correlation between it and its ability to manipulate an economy. To start, I will examine one of its central policies...
2) Davis, Gareth. The Destruction of the Second Bank of the United States Rationale and
McCallum, Bennett T. "Crucial issues concerning central bank independence." Journal of Monetary Economics 39.1 (1997): 99-112.
The term Monetary policy refers to the method through which a country’s monetary authority, such as the Federal Reserve or the Bank of England control money supply for the aim of promoting economic stability and growth and is primarily achieved by the targeting of various interest rates. Monetary policy may be either contractionary or expansionary whereby a contractionary policy reduces the money supply, reduces the rate at which money is supplied or sets about an increase in interest rates. Expansionary policies on the other hand increase the supply of money or lower the interest rates. Interest rates may also be referred to as tight if their aim is to reduce inflation; neutral, if their aim is neither inflation reduction nor growth stimulation; or, accommodative, if aimed at stimulating growth. Monetary policies have a great impact on the economic stability of a country and if not well formulated, may lead to economic calamities (Reinhart & Rogoff, 2013). The current monetary policy of the United States Federal Reserve while being accommodative and expansionary so as to stimulate growth after the 2008 recession, will lead to an economic pitfall if maintained in its current state. This paper will examine this current policy, its strengths and weaknesses as well as recommendations that will ensure economic stability.
Author Unknown (1994). The Federal Reserve System: Purposes and Functions (5th ed.) Published by Library of Congress
Inflation and unemployment are two key elements when evaluating a whole economy and it is also easy to get those figures from National Bureau of Statistics when you want to evaluate it. However, the relationship between them is a controversial topic, which has been debated by economists for decades. From some famous economists such as Paul Samuelson, Milton Freidman etc to some infamous economists, this topic received a lot of attention. However, it is this debate that makes the thinking about it evolve. In this essay, the controversial topic will be discussed by viewing different economists’ opinions on that according to time sequencing. But before started, it is worthy getting a better understanding of the terms, inflation and unemployment.
As a result of this economic growth families will begin to feel more confident and will begin to spend more of their money instead of saving it because they believe that will receive a pay raise or will find a better job. (Amadeo, 2016) Borrowing also increases when economic activity is high people begin to borrow from banks and other places because they feel that the government has been doing a great job managing the economy. (Amadeo, 2016) As we have seen in 2008 people should never get to confident in the economy because our economic bubbles are used to crashing when they are doing very well and it’s never really the people’s fault it’s the governments. Although inflation begins to rise when the economy is doing great one of the things that is known to bring prices down is competition among businesses. Competition is great because one company will attempt to sell a product for a cheaper price than another company which results in lower prices the same as you see with cell phones and automobiles. Higher prices can also be caused by technological innovations when people are expecting a new product the producer can sell it for a higher price because they know that consumers will spend almost any amont of money to obtain that product. (Amadeo, 2016) Higher demand for new products will increase employment to meet those demands and inflation will rise which will benefit the economy tremendously. Whenever the price level increases, spending must also increase to be able to buy the same amount of goods and
It is difficult for government to achieve all the macroeconomics objectives at the same time. Conflicts between macroeconomics objectives means a policy irritating aggregate demand may reduce unemployment in the short term but launch a period of higher inflation and exacerbate the current account of the balance of payments which can also dividend into main objectives and additional objectives (N. T. Macdonald,