A Broader Mandate

• Author: Luis Jácome and Tommaso Mancini-Griffoli
• Position: a Deputy Division Chief and is a Financial Sector Expert, both in the IMF’s Monetary and Capital Markets Department.

In the decades leading up to the 2008 global financial crisis, country after country became persuaded that to achieve price stability, central banks should focus solely on that goal and operate independently of political authorities, who often have short-term horizons. But in recent years that consensus has frayed somewhat, as authorities and others have come to reassess the role that central banks should play.

A number of academics and analysts have suggested that central banks should embrace a broader mandate that adds to inflation aims. Perhaps the most concrete suggestion is that central banks play an active role in preserving financial stability, avoiding systemic financial crises by limiting excessive credit growth and borrowing. This would take the central bank beyond today’s role of regulating individual banks. Some suggest that central banks should have a dual and equal mandate of controlling inflation as well as supporting full employment and growth. Under most current mandates, central banks concern themselves with employment and growth only as far as they affect inflation.

But such a broader mandate would inevitably come to rub against political considerations, and unelected central bankers could see their independence constrained. We examine the channels through which independence could wane—and the associated costs. We argue that depending on the mandate, it may well be justified for central banks to have less independence, but that legal and institutional arrangements should protect the core of monetary policy independence—which has worked so well in containing inflation.

While some central banks could see their mandates expand, others might see them reduced. In an environment of potentially severe fiscal difficulties for governments, central banks could feel significant pressure to ease financing strains—for example, by keeping interest rates low. Central banks should prepare for this pressure.

Roots of independence

The value of granting central banks independence from government authorities in setting monetary policy is well rooted in economic theory. Kydland and Prescott (1977), Barro and Gordon (1983), and Rogoff (1985) all showed that independent central banks tend to avoid the inflationary bias that occurs as a result of self-interested political intervention. In proposing to grant independence to the Bank of England when he became prime minister in 1997, Tony Blair said he became “convinced long ago that for politicians to set the interest rate was to confuse economics and politics.”

Central bank independence has largely proved effective in achieving and preserving low inflation. It has been extensively documented that higher independence and lower inflation go hand in hand (Cukierman, 2008). Latin America is a case in point. The region today has one of the lowest and most stable inflation rates in the world, although there are a few exceptions. That is in sharp contrast to its history of very high inflation—which reached more than 500 percent in 1990—before most Latin American nations granted independence to their central banks.

The case for making central banks independent is not self-evident. The public must have substantial confidence in the bank’s ability to carry out its mandate and in the benefits that will accrue to society. On the face...