Central Banks and Inflation
John T. Woolley
One need not read far in the economic literature on inflation to learn that inflation is ultimately a monetary phenomenon. That is, it is not easy to conceive of the conditions under which inflation could continue at a high level or could accelerate for sustained periods unless the money supply also grew or accelerated. The most vigorous statement of this position has come from monetarist economists. Some have seemed to believe that the solution to the problem of inflation is rather simple-- instruct the monetary authority to control the money supply. From that point of view, monetary authorities appear to be perverse or ignorant-- else why haven't they done the right thing already? A more sophisticated approach recognizes that the reasons for the behavior of the monetary authority are not obvious. Thus, for example, Karl Brunner has suggested that "one chapter on the political economy of inflation" should deal with central banks--with how they conceive of their task, and how their behavior relates to the government budget.1
Rather than castigating central banks for permitting inflation, students of inflation need to understand why it is that central banks do what they do. What is the role of the central bank in economic policymaking? What kinds of political constraints are there on the choices of central banks? How plausible is the widely held notion that central banks have some meaningful form of independence from politics--and, thus, behave in ways not fundamentally shaped by politics?
This chapter argues that there is a small but meaningful degree of independence that can be attained by central banks under certain conditions. However, the dominant political and economic coalition that rules____________________