Rejected Central Bank Independence.pdf

Central bank independence (CBI) became widely accepted about 30 years ago, but has been under attack in both developed and emerging markets. The idea of CBI originated in the late 20th century, emphasizing the importance of monetary policy free from political influences. However, recent events have challenged this concept, with critics arguing that central banks were unaware of financial stability risks and ill-prepared to respond to the financial crisis. The traditional view of central bank functions, associated with Walter Bagehot, emphasizes the lender of last resort role, but this was diminished in importance as macroeconomic policy became the focus. The 2007-09 financial crisis brought a renewed emphasis on the lender of last resort function, and the use of central bank lending to ensure financial stability. Despite the majority of academics and central bank practitioners continuing to support CBI, its reputation was damaged by the crisis, and questions about its effectiveness and accountability have arisen. The seeds of doubt about independence were planted, and more criticism continues to emerge, with some arguing that central banks fueled the credit expansion that resulted in the crisis and failed to achieve financial stability. The crisis also highlighted the distributional consequences of central bank decisions, with quantitative easing benefiting rich owners of financial assets while poorer savers received little. Recent developments may mark a watershed in the public approach to central banks, with the public potentially becoming less tolerant of leaving decisions with significant distributional and fiscal consequences to unelected bodies.