Two Fallacies Concerning Central Bank Independence

15 Pages Posted: 11 Jun 2000 Last revised: 21 Sep 2000

See all articles by Bennett T. McCallum

Bennett T. McCallum

Carnegie Mellon University - David A. Tepper School of Business; National Bureau of Economic Research (NBER)

Date Written: March 1995

Abstract

This paper takes issue with two basic conclusions prevalent in the literature on central bank behavior. First, the paper argues that it is inappropriate to presume that central banks will, in the absence of any precommitment technology, necessarily behave in a 'discretionary' fashion that implies an inflationary bias. Since there is no functional connection between average rates of money creation (or inflation) and policy responsiveness to cyclical disturbances, it is entirely feasible for the bias to be avoided. In other words, there is no necessary tradeoff between 'flexibility and commitment.' Second, to the extent that the absence of any absolute precommitment technology is nevertheless a problem, it will apply to a consolidated central bank plus government entity as well as to the central bank alone. Thus contracts between governments and central banks do not overcome the motivation for dynamic inconsistency, they merely relocate it.

Suggested Citation

McCallum, Bennett T., Two Fallacies Concerning Central Bank Independence (March 1995). NBER Working Paper No. w5075, Available at SSRN: https://ssrn.com/abstract=225853

Bennett T. McCallum (Contact Author)

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