The Need for Rules and Constraints: Independent (and Conservative) Central Banks and Authorities to Limit Discretionary Policy Action
Another solution for limiting the tendency of governments to create inflation could be tying money growth to some macroeconomic indicator. A further alternative is for the constituency or government to delegate monetary policy to independent institutions not plagued by time inconsistency and opportunistic behaviour, with incentive structures different from those of politicians, in order to acquire a credible commitment.
Such an institution could be a conservative central banker, i.e. a banker assigning employment a lower weight than that of society or the government. Rogoff (1985a) shows that this will be able to attain a lower level of inflation without reducing employment. On this, see also de Haan and Sturm (1992), Cukierman (1994) and Akhtar (1995). Appointing a conservative central banker introduces a conflict with the government that can be avoided by setting rules that govern the independent monetary authority, i.e. by establishing a target conservative central bank (Svensson 1997). These steps represent the best way to obtain a commitment not to pursue inflationary, and ineffective, policies.[30] We are thus (almost) back to Friedman, with two (significant) details to be added: one that rules are a way to cope with a more general problem faced by governments, that of their credibility, and the other that once price stability is not in question, stabilisation policies are possible. However, this is exactly the description of the status of the ECB, which has to guarantee a certain inflation rate in the medium run as its preeminent target but can also pursue other objectives, provided that these do not prejudge the attainment of its predominant target.Delegation to independent authorities is a case more general than that of conservative central banks, as other independent authorities could be devised (Majone 1994, 1996).
One recent suggestion is that of ‘fiscal councils' (for recent literature, see Hagemann 2010; Calmfors and Wren-Lewis, 2011; IMF 2013). These institutions are responsible for monitoring the economic health of the world's larger economies. The IMF and the European Commission recommend that politicians place themselves under the scrutiny of an independent fiscal council, which could ensure monitoring of the government budget in the light of its impact on growth, employment and long-run sustainability of public and private finances. These councils should increase credibility and commitment to a set of sustainable fiscal policies by providing politically neutral monitoring to the economy as a whole. This idea has been implemented in many European countries, such as Sweden (Swedish Fiscal Council), the United Kingdom (Office of Budget Responsibility) and, more recently, the European Union (European Fiscal Board).In countries where the creation of independent authorities is difficult to implement or commitment to a rule is not credible, other solutions have been devised. In general, the favour for an ‘external constraint' was very diffuse (Giavazzi and Pagano 1988; Sibert 1999) as a prescription for governments in high-inflation countries. Such constraints should tie their (inflationary) hands by committing them to a fixed exchange rate with lower-inflation countries. Thus, monetary policy would credibly be delegated to an external entity, and private agents would no longer expect their governments to inflate the economy and would act consistently. Therefore, they would adjust their conduct and rely on instruments other than higher mark-ups to pursue their revenue or profit targets (Carli 1996). In particular, the idea was common of the need to tie these countries' monetary policies (and possibly also other policy tools) to some kind of policy rule, such as dollarisation or a currency board or a system of fixed exchange rates such as that represented by the European Monetary System (EMS), first, and by a currency union of the EMU kind, later.
2.7