Central Bank Independence

5 May 2017

The Editor at The Economist

Your editorial on central bank independence (“The wars of independence”, April 29th) refers to “the British model, in which the government sets an inflation target for the central bank to follow”.

This is more accurately termed “the New Zealand model”.  The New Zealand central bank was not only the first to formally adopt an inflation target in 1988, it was also the first to combine explicit political involvement in the choice of the inflation target with complete instrument independence in delivering that target.

The Reserve Bank of New Zealand Act 1989 required the Minister of Finance and the Governor of the central bank to agree on the inflation target to be pursued during the term of the Governor’s appointment, required that target to be made public (a crucial safeguard), gave the Governor full independence to choose the monetary policy settings needed to deliver the target, and held the Governor accountable for achieving it.

This model, of explicit political involvement in setting the target with full independence over the monetary policy needed to deliver it, was initiated in early 1990 in New Zealand, and subsequently copied in Canada, Australia, Sweden and the United Kingdom.

Allowing explicit and public political involvement in the choice of the target inflation rate, while leaving the central bank totally independent about how to deliver it, would reduce a lot of the strain between politicians and central banks.  It’s very hard for the government to criticize a central bank for having policy too tight if inflation is within the inflation target, and is projected to remain so.

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Copyright © 2020 Don Brash.