Central bank independence
Also called: Central bank autonomy · Topic: Banking, Credit Creation and Monetary Policy · NCERT: Beyond NCERT
Meaning
Central bank independence means that the central bank sets monetary policy free from political interference. Governments may want low rates before elections even if inflation rises later. An independent central bank can resist that pressure, so people trust its promise to control inflation. This trust is called credibility. There are two kinds of independence. Goal independence means the central bank chooses its own target. Instrument independence means it chooses how to reach a target set by someone else.
Example
In India, the Government of India sets the inflation target of CPI-Combined 4%, within a 2-6% band, in consultation with the RBI. The Monetary Policy Committee then decides the repo rate on its own. So the RBI has instrument independence but not goal independence. Section 7 of the RBI Act still lets the government issue directions to the RBI. Consultations under it during the 2018 RBI-government standoff were widely reported.
Don't confuse with
- Fiscal dominance: in fiscal dominance, the government's large deficits end up driving monetary policy. It is the opposite of independence.
Related concepts
- Inflation targeting
- Flexible inflation targeting
- Monetary Policy Committee
- Monetary policy stance
- Fiscal dominance
- Taylor rule
- Neutral rate of interest