Central bank independence : a
            critical view
While expansive literature on central
            bank independence contains some criticisms to the
            independent central bank quasi-paradigm, few critical
            analyses have been undertaken in the years between Friedman
            (1962) and Posen (1994). The author extends Posen's
            analysis to developing countries, discussing more broadly
            and systematically the reasons why merely instituting an
            independent central bank may not bring about its professed
            benefits, especially in developing countries. The author
            argues that widely reported empirical tests that are
            purported to support the central bank independence
            proposition are plagued by potential problems of
            simultaneity, reverse causality, missing variables, and
            measurement errors. Yet one can not make positive
            recommendations about institutional arrangements for central
            banks if causality relations are not well established.
            Institutions are shaped by a country's record of and
            preferences for inflation and may have little influence on
            them.  The author also argues that the purported benefits of
            an independent central bank may be eroded by conflicts
            between fiscal and monetary policy and by inherent problems
            of central bank institutional design (especially mechanisms
            for board appointments, public accountability, and budgetary
            control). If these institutional problems are not solved,
            problems of dynamic inconsistency traditionally associated
            with monetary policy are not eliminated, but merely
            transformed. The author suggests that the benefits of
            central bank independence are less likely obtained in less
            developed countries with shallow financial markets.
            Accordingly, central bank independence should be granted at
            a later stage in a country's financial sector
            development. If a less developed country seeks to establish
            a low-inflation path, it should concentrate on instituting
            financial policy reforms (such as liberalization and
            privatization) that bolster opposition to inflation rather
            than easily reversible and practically meaningless changes
            in legal and institutional structures. This will better
            ensure the sustainability -- and hence the credibility -- of
            the government's anti-inflation stance. Fiscal policy
            is often at the root of macroeconomic disturbances in
            developing countries. Fiscal policy is more deserving of
            special protection from politics because of fiscal dominance
            over monetary policy and its greater vulnerability to
            private interests. The author suggests that the solution
            might be to make fiscal policy less susceptible to political
            pressures by creating an independent fiscal board. Tying the
            fiscal hands of government may seem a far-fetched idea. But
            would it not make more sense to force discipline on fiscal
            policy directly rather than indirectly through monetary policy?