Central Bank Essay ⋆ Political Science Essay Examples ⋆ EssayEmpire

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Central banks are government or quasi-governmental agencies with a long history. For example, the Bank of England was chartered in the seventeenth century. But the prevalence and extensive policy-making authority of modern central banks is a post–World War II (1939–1945) phenomenon. While modern central banks vary in their institutional relationships with elected officials, their policy responsibilities typically include the development and implementation of monetary policy and regulation of the banking and, sometimes, the broader financial industry.

Monetary policy focuses on currency management. Monetary policy instruments available to central banks vary, but they may include authority over reserve requirements for commercial banks; the ability to lend directly to banks and, in some cases, other financial institutions; and the capacity to participate in open market operations (the purchase and sale of government securities). These responsibilities often include serving as a lender of last resort. Each policy tool is designed to influence the extent to which cash is available to commercial markets. Central banks manage the availability of financial resources in an effort to achieve their statutory policy goals. These goals often include stable prices, high employment, and economic growth.

Politics Of Central Banking

The cross-national variation in central banks mirrors the cross-national variation in governmental systems. Some central banks have federal structures (such as the German Bundesbank or the American Federal Reserve System). Other central banks, like the Bank of England, have a centralized organizational structure. Finally, at least one central bank, the European Central Bank, is a multinational financial institution. Central banks also vary in the extent to which elected officials may manipulate or control them. In some cases, such as the case of the Federal Reserve, there is a considerable degree of both formal and actual independence. Federal Reserve governors are appointed for long terms (fourteen years), and neither Congress nor the president can remove a Federal Reserve governor before the end of the term without cause. Also, the Federal Reserve does not depend upon an annual budgetary allocation from Congress to cover its operating expenses. Not all central banks have these sorts of institutional protections against the encroachment of elected officials.

Central bank independence from the influence of elected officials is not trivial, nor is it an easy concept to measure. Political economists have long argued that politicians have strong electoral incentives to manipulate monetary policy.

Some argue that politicians use monetary policy to boost economic growth near elections; others contend that politicians manipulate monetary policy to achieve partisan goals. Political economists also argue that the political manipulation of monetary policy tends to induce inflation without producing significant long-term increases in income or employment. Substantial empirical evidence supports the presence of an inverse relationship between central bank independence and inflation, the variability of inflation, and the variability of interest rates. There is, however, little evidence of a strong relationship between central bank independence and real variables such as employment or income growth.

Central Banks In The Twenty-First Century

Research on the implications of central bank independence (CBI) flowed out of a time (and scholarly literature) focused on a highly inflationary economic environment (from the stagflation of the mid-1970s to hyperinflation in various countries during the final twenty-five years of the twentieth century).The deflationary pressures of the dramatic economic decline since 2008 are uncharted territory for central banks. The evidence for the macroeconomic significance of the relationship between elected officials and central banks is based on era in which significant inflation was widely common. It is not clear, for example, that actual CBI is positively associated with deflation, but in an economic era in which deflationary pressures may be far more significant—during or immediately after a global recession—the political and economic implications of CBI remain to be seen.

Also significant, the political and economic research on central banks has focused overwhelmingly on traditional monetary policy making. The extent to which an understanding of the political economy of central banking extends to contexts in which central banks take on increasing policy responsibilities—from additional oversight duties to increased lending to financial concerns besides commercial banks—remains to be seen.

Bibliography:

Alesina, Alberto, Nouriel Roubini, and Gerald Cohen. Political Cycles and the Macroeconomy. Cambridge, Mass.: MIT Press, 1997.
Alesina, Alberto, and Lawrence H. Summers. “Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence.” Journal of Money, Credit, and Banking 25 (1993): 151–162.
Cukierman, Alex. “Central Bank Independence and Monetary Policymaking Institutions: Past, Present, and Future.” European Journal of Political Economy 24 (2008): 722–736.
Central Bank Strategy, Credibility, and Independence: Theory and Evidence. Cambridge, Mass.: MIT Press, 1991.
Drazen, Allan. Political Economy in Macroeconomics. Princeton: Princeton University Press, 2001.
Morris, Irwin L. Congress, the President, and the Federal Reserve: The Politics of American Monetary Policymaking. Ann Arbor: University of Michigan Press, 2000.