Central Bank Design

Central Bank Design

Design 1         

Design 1 policy allows Central Banks to make decisions irrespective of political considerations. For instance, in the US, Congress determined that the best way to support the Federal Reserve to attain full employment and price stability is by letting them work independently (Federal Reserve, 2014). That way, the Federal Reserve makes decisions based on existing evidence, data, and analysis. Besides, evidence from the world over has proven that Central Banks that work independently of political interference achieve better economic outcomes for their people instead of being controlled. The political class may set policies for central banks, but they allow them to work independently under the Design 1 policy.

Although central bank independence has many positive benefits, a few drawbacks are associated with their design. Operational discretion gives central banks too much power to operate in secrecy. As a result, some of the decisions they make come as a surprise. Some of the world’s biggest fiscal crises can be traced to central banks’ actions arising from their secretive operations. In addition, central banks tend to act in the interest of large banks instead of common citizens. After the 2008 financial crisis, central banks in the US followed the policy of quantitative easing to assist commercial banks. The policy led to one of the largest inflation crises to ever happen.

Design 2

Central banks need to offer their funding proposals to governments to actualize the development plan. Governments in developed and developing nations face constraints that limit their ability to bring productive employment and enhance economic growth. Funding central banks help them foster growth by compensating traditional and unconventional monetary policies (Sprague, 1909). Funding proposals are also important because it goes a long way to ensure the central bank pursues similar policies as the government of the day.

On the flip side, writing funding proposals to a national government amounts to some level of control. It means the government can intervene directly or indirectly with the central bank’s operations, a recipe for a stunted institution (Sprague, 1909). Also, developing nations are sometimes faced with crises like hunger and war, which may force governments to withdraw funding from economic development altogether.

Design 3

Policymakers in democracies have solid control over the policy directions the country will pursue. As a result, there is a need to ensure continuity of government policy by ensuring top central bank policymakers are appointed after every political electoral cycle (4 years). A change in citizens’ expectations also demands that policymakers be changed to meet public interests (Franzese, 2002). In a nutshell, political behavior significantly influences fiscal and monetary policy.

However, tying central banks’ management with partisan politics may be ineffective in unstable democracies. That is the case, especially in poor and developing countries where politicians are self-seeking and not interested in citizens’ economic welfare (Franzese, 2002). Central government leaders have little influence on monetary policy in federal systems; hence needless to tie partisan politics with bank management.

Recommendation

I recommend Design 1 for the new, independent country. The design allows the central bank to act independently of political influence. In this design, the central bank will focus on available analysis and data before making crucial monetary decisions by working independently. Leaving such important aspects of the economy open to political influence may lead to populist choices that may affect a country’s fiscal position.

References

Federal Reserve. (2014). The Fed – Why is it important to separate Federal Reserve monetary policy decisions from political influence? Board of Governors of the Federal Reserve System. https://www.federalreserve.gov/faqs/why-is-it-important-to-separate-federal-reserve-monetary-policy-decisions-from-political-influence.htm

Franzese, R. J. (2002). ELECTORAL AND PARTISANCYCLES IN ECONOMIC POLICIES AND OUTCOMES. Annual Review of Political Science, 5(1), 369–421. https://doi.org/10.1146/annurev.polisci.5.112801.080924

Sprague, O. M. W. (1909). The Proposal for a Central Bank in the United States: A Critical View. The Quarterly Journal of Economics, 23(3), 363. https://doi.org/10.2307/1884772

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Imagine you are advising the leadership of a new, independent country for the design of their central bank. In 1–2 pages, do the following:

Describe one benefit and one drawback for each type of central bank design listed below:
Design 1 – Central bank policy decisions that are irreversible or central bank policy decisions that can be overturned by the democratically elected government.
Design 2 – The central bank has to submit a proposal for funding to the government each year or the central bank finances itself from the earnings on its assets and turns the balance over to the government.
Design 3 – The central bank policymakers are appointed for periods of four years to coincide with the electoral cycle for the government or the central bank policymakers are appointed for 14-year terms.
In 1–2 paragraphs, identify the design you would recommend for this country and why.
Be sure to describe any necessary characteristics and assumptions about this country to support your recommendation.