Question

Why do most economists believe that it is important for a country’s central bank be independent of the rest of the country’s central government? What was the most recent US Federal Reserve's policy-making Federal Open Market Committee (FOMC) report?

Answer 1

The idea of independent central bank goes back at least as far as the U.S. Federal Reserve was established in 1913. This came into its own after the breakdown of the semi-fixed exchange rate regime of Bretton Woods in the early 1970s–set up by the leading economies in 1944–and the US decision to abandon the convertibility of the currency–the mechanism by which dollar holders were able to redeem them from the government in exchange for gold. The goal is to separate monetary policy from political interference and electoral pressure to achieve short-term economic growth at the risk of longer-term cost of inflation.

As a safeguard against debt monetisation, freedom from the tax authority is particularly important. A strong government commitment to central bank independence is perceived to lower the cost of lowering inflation, as so much interest rates need not be increased. There are two primary models: independence "target" and independence "operational." In the former, the bank has the power to set monetary policy targets, such as price stability and an inflation target.

The Federal Reserve has the tools necessary to increase or decrease the money supply through open market operations, changing the discount rate and setting bank reserve requirements. The Board of Governors of the Fed is responsible for setting the discount rate and reserve ratios, while the FOMC is primarily responsible for open market operations including the purchase and sale of government securities. For example, the Fed would sell government securities for sale to increase the money supply and decrease the amount of money available in the banking system. Securities acquired by the FOMC are deposited in the Fed's System Open Market Account (SOMA), which consists of a portfolio both domestic and foreign. The fund is held by the U.S. Treasuries and shares of the Federal Agency, while international portfolio retains euro and Japanese yen-denominated portfolios.