NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Two Fallacies Concerning Central Bank Independence

Bennett T. McCallum

NBER Working Paper No. 5075 (Also Reprint No. r1979)
Issued in March 1995
NBER Program(s):   EFG   ME

This paper takes issue with two basic conclusions prevalent in the literature on central bank behavior. First, the paper argues that it is inappropriate to presume that central banks will, in the absence of any precommitment technology, necessarily behave in a 'discretionary' fashion that implies an inflationary bias. Since there is no functional connection between average rates of money creation (or inflation) and policy responsiveness to cyclical disturbances, it is entirely feasible for the bias to be avoided. In other words, there is no necessary tradeoff between 'flexibility and commitment.' Second, to the extent that the absence of any absolute precommitment technology is nevertheless a problem, it will apply to a consolidated central bank plus government entity as well as to the central bank alone. Thus contracts between governments and central banks do not overcome the motivation for dynamic inconsistency, they merely relocate it.

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Document Object Identifier (DOI): 10.3386/w5075

Published: American Economic Review Papers and Proceedings, vol. 85, no. 2, pp. 207- 211 (May 1995).

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