Structure

The central bank should have a clearly defined mandate that places price

stability as the bank’s number one objective. By price stability, I refer to a positive

but low inflation rate of between 1% and 3%.

The treasury should have the power to override all central bank decisions but this

power should be exercised at cost to the treasury.

The central bank should not be required to finance the government deficit or

manage the public debt.

As in New Zealand the governor should be appointed by the chancellor but from

a short list constructed by the banks board of governors. The tenure of the

governor should last for a longer period than a cycle of government, i.e., five

years.
 
 

Conduct

The central bank should set publicly announced medium term inflation targets

and other policy goals.

The central bank should have complete control of monetary policy instruments

for example interest rates and exchange rates. The central bank should be

mindful of government policy and consult with the treasury before implementing

policy. However, the bank should be under no obligation to accept government

advise.
 
 

Performance

Due to the undemocratic nature of a highly independent central bank, the bank

must be held accountable for its actions. Firstly, it must be held accountable for

obtaining all the goals set out in its mandate within the specified time period

(unless there is good reason) and it must explain its actions to the public. This

should take the form of a verbal justification, perhaps to parliament and a

periodical Inflation Report as in the United Kingdom.
 

It is important to note that a highly independent central bank is not a panacea. It

is not the all “purpose cure” for all monetary problems and certainty cannot

deliver price stability in isolation.

For inflation to kept under control, central bank independence must be co-

ordinated with all political and financial institutions. In fact, the strongest weapon

a nation may have in combating inflation may not be an independent central bank

but instead the inflation aversion of its public. Many commentators hold the view

that Germany has been able to maintain price stability for the last 40 years

because of its inflation adverse public, and it is this public aversion that has

resulted in the establishment of such a highly independent central bank and not

vice-versa. Clearly the structure of the Bundesbank have contributed greatly

towards Germany’s success. As noted by Cukierman (1994), history has shown

us that central bank independence has acted as a shield towards inflation but not

as the cure itself.

Once inflation has been allowed to develop the central bank alone is incapable of

stabilizing this effect. It then takes the concerted efforts of the whole

establishment to control prices. Once inflation has been brought under control,

then an independent central bank can become pivotal in preventing the upsurge

of future inflation.
 

In conclusion I believe that the precise form of central bank independence is not

the most important factor in the control of prices. However a highly organised

central bank with greater independence coupled with sufficient accountability can

be a valuable tool in combating excessive inflation. Such an institution will be

especially useful in poor credibility countries who have not been able to build

reputation over a sustained period of time. An independent central bank can only

be part of a system to keep inflation under control. It cannot be viewed as the

system itself.