Central Bank Independence: Implications in a Global Macroeconomic Environment

Abstract

This paper analyzes the role of central bank independence as a monetary policy tool, within a global framework. I begin with a historical analysis of how CBI emerged and developed over the 20th century, tracing the role of geopolitical forces and theoretical developments in shaping this institutional idea. I then consider heterodox opinions on CBI, which criticize it's foundational lack of democratic legitimacy, question its empirical efficacy, or otherwise complicate the simplistic theoretical picture. Finally, the bulk of the paper constitutes a mathematical game-theoretic analysis of monetary policy in a two-country model (U.S. - China). I subject the model to a shock representing loss of Federal Reserve independence, and interpret the results. I find that loss of Fed independence creates economic disturbances in both of the model's countries, and that this disturbance begins the moment that loss of independence is factored into economic expectations. An additional finding is that international coordination effectively contains most of the economic ill effects, by subjecting the Federal reserve to a new constraint and resolving the game-theoretic conflict between U.S. and China monetary policymakers.