Posen, Adam. (1993). "Why Central Bank Independence does not Cause Low Inflation: There is no Institutional Fix for Politics". In R. O'Brien (Ed.), Finance and the International Economy (pp. 41-66). Oxford: Oxford University Press.
There is increased zeal to make central banks independent and inflation fighters. It looks like it is a free lunch with the possible benefit of long-term economic growth. Posen argues that, “…the causal linkage between central bank independence and low inflation is illusory” (41). His claim is that it is, as the title of his piece indicates, a problem of politics.
“The institutional fix of an independent CB is supposed to offer protection from inflation through three mechanisms—increasing the credibility of commitments to prices stability, assuring a higher priority on inflation fighting in the net preference of the public sector, and putting up barriers to the monetization of government expenditure” (42). The first isn’t played out by the facts. The second may be slightly true, but CBs are also concerned about exchange rates and growth.
“An empirically supported explanation of the association between CB independence and low inflation can only be arrived at through a proper understanding of politics” (46). Democratic politics is not a tool that is going to settle institutional problems (as per his sub title to this section: Nothing Contentions is ever Settled in Democracies). Politically important and influential interest groups will always be involved in the creation of caustic institutions in certain political systems. This he calls the “interests not institutions” thesis (47).
“Financial sectors having universal banking are expected to have stronger anti-inflationary sentiment than those without,” and, “…the less regulatory power of the CB over the financial sector, the more strength of opposition to inflation by the sector is to be expected,” and, “Where a country’s party system is more fractionalized, financial expert opinion is expected to be less influential,” and, “…financial opposition to inflation is expected to be more effective in federal systems of government” (48-9).
“The fundamental argument of this paper, that there is no institutional ‘fix’ for the redistributive struggle over monetary policy, implies that CBs designed with similar degrees of statutory independence will offer significantly differing degrees of protection from inflation over time as they political situation alters” (53).
