How Other Central Banks Work

By Sibert, Anne | The World and I, April 1999 | Go to article overview
Save to active project

How Other Central Banks Work


Sibert, Anne, The World and I


A nation's ability to control inflation depends on the structure of its central bank and the relationship between the central bank and the government.

Anation's ability to control inflation depends on the structure of its central bank and the relationship between the central bank and the government. Central banks vary widely in their structure and effectiveness at maintaining price stability.

Perhaps the best way to shield an economy from inflation is to make the central bank independent and give it a legally binding mandate to achieve price stability. Central bank independence can protect the nation from opportunistic politicians desirous of extracting short-run gains from price increases if the central bank's objectives and technical competence cause it to pursue the common good more consistently than would a partisan political government.

Empirical research suggests that more-independent central banks produce lower inflation. A legal directive reflecting the long-run goals of society would reduce a central bank's own inflation bias. A combination of a clearly stated goal and the freedom to achieve it without government interference might be referred to as operational independence.

The first country to formally introduce inflation targeting was New Zealand. The Reserve Bank of New Zealand Act of 1989 statutorily binds the bank to price stability. The target is the result of negotiations between the central bank head and the finance minister. To give the act clout, the head of the central bank can be fired if he misses his objective. The central bank has had some success in meeting its ambitious target.

Other countries have recently introduced legislation aimed at increasing their central bank's operational independence. In June 1997, the Bank of England was given an inflation target and independence to carry it out (although the government may overrule the bank in exceptional circumstances.) This was formalized in the Bank of England Act of June 1998.

June 1997 also saw the enactment of the Bank of Japan Law, which gave the Bank of Japan greater independence and ordered it to pursue low inflation. As a result, government officials no longer sit on the bank's monetary policy committee and cannot instruct the bank. No explicit inflation targets were set, however.

The importance of the euro

Eleven European countries--including Germany, France, and Italy--have formed a monetary union and adopted a common currency called the euro. Euro notes will be introduced in January 2002, and national currencies will lose their legal tender status in July of that year. A common monetary policy is now made by a new central bank, the European Central Bank (ECB). The Maastricht Treaty and its annexed protocols describe the institutional structure and policy of a common central bank.

The treaty makes the central bank highly independent but is more ambiguous about its policy prescription than is the Bank of England Act. It proscribes the ECB from both asking or receiving advice from member countries' governments. It calls for price stability to be the ECB's main objective but does not set an inflation target. Instead, the bank has adopted its own.

In contrast, although the Federal Reserve is relatively independent, the U.S. monetary arrangements do not give overriding importance to price stability. The Fed is not given an inflation target (by law, by the executive, or by Congress), and it does not set its own inflation target.

The Federal Reserve Act lays out the goals of monetary policy. It specifies that, in conducting monetary policy, the Federal Reserve System and the Federal Open Market Committee (FOMC) should seek "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." The Fed is unique among modern central banks in having "maximum employment" (whatever that may mean) on a par with price stability and moderate long-term interest rates among its objectives.

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
Loading One moment ...
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited article

How Other Central Banks Work
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

While we understand printed pages are helpful to our users, this limitation is necessary to help protect our publishers' copyrighted material and prevent its unlawful distribution. We are sorry for any inconvenience.
Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.

Are you sure you want to delete this highlight?