Accountability is an issue that cannot be ignored in any discussion concerning

central bank independence. As many countries move towards greater central

Bank autonomy, it has become more apparent that central bank independence

delegates responsibility for a large sector of the economy (i.e. monetary policy) to

an unelected institution. This clearly has implications for democracy so it

becomes a necessity to make any such institution accountable for its actions.
 
 

The primary concern I have concerning the Rogoff model is its lack of central

bank accountability. In fact, the model suggests that there is no need to regulate

the activity of the central bank or even provide penalties for its failure to achieve

the specified objectives. Simply leaving an inflation – averse bank to its own

devices will ensure a desirable level of inflation. Rogoff’s central bank has traded

power for accountability and this scenario appears to me to be a dangerous one.
 
 

Lohmann (1992) provides an extension to the Rogoff rule where although the

central bank controls monetary policy, it can be overruled by the government if

there is a significant enough disturbance.
 

The ability of the government to overrule will alter the behaviour of the central

bank in the sense that it will respond proportionally more strongly to large than to

small disturbances. The theory holds that under this regime the government

should never have to overrule the central bank. It is an improvement on the

Rogoff model as it attempts to resolve the issue of accountability.

The method of reconciling independence and accountability which immediately

presents itself is within the principal – agent / optimal contract framework. Here,

there is a legal obligation for the central bank to perform a duty and all

responsibilities, powers and penalties for failure are clearly spelled out in the

central bank mandate. Even for a central bank which has little independence

there are still benefits associated with publicly announcing objectives, intentions

and actions in order to influence public expectations – and thus lower the cost of

achieving central bank goals. The bank can increase its reputation and credibility

by educating the public about the benefits of price stability instead of engaging

agents in a game theoretic framework. This action may at least bring about

greater central bank accountability – de facto making the central bank’s actions

and objectives more transparent by using its credibility, or reputation as an

incentive to deliver on its promises.

In both the Rogoff and the principal – agent models, it is assumed that the

authorities ’ inflation preferences and the underlying economy are known to all

agents. In reality, this is usually not the case. For example, short – run pressures

may alter the authorities ‘ preferences, which is unobservable to agents. Even if

the central bank is given independence, it is still unlikely that agents will be

aware of their preferences with certainty, especially when reputation and

credibility are poor. Agents will become uncertain about how the authorities will

react in certain situations and the economy will resort back to the game theoretic

framework. So simply delegating monetary control to the central bank may be not

enough to remove this uncertainty felt by agents.
 

As  noted by Briault et al, (1996) one way the authorities can circumvent this

problem is through reputation. That is providing information through deed. It

could be argued that countries such as Japan and Germany have shown that a

consistent track record reduces inflation uncertainty. In Japan ( which has had

low central bank independence ), many experts argue that the openness of the

authorities’ inflation preferences through stability orientated – policy actions has

been central in helping to maintain low inflation.

Reputations develop over long periods of time through actions. Transparency

can have the same effect but through the use words. These words can take the

form of speeches, bulletins, press releases, parliamentary hearings, inflation

reports and minutes from monetary policy meetings. All these forms provide

agents with information needed to make sound economic decisions. Thus agents

will require less compensation for inflation uncertainty, leading to lower levels of

inflation.

Countries with low credibility are unable to use reputation as a tool and therefore

must rely on transparency in order to raise credibility. Transparency allows poor

credibility countries to reassure agents that it is not their intention to maximise

inflation bias and thus it may act as a substitute for reputation.