Using the example of Germany, he argued that the primary common cause of low inflation and an independent central bank is society’s aversion to inflation. However, this did not change the consensus that independent inflation-targeting central banks were the most effective solution to the problem of inflationary bias. Central bankers enjoyed a growing, broad-based esteem. Charles Goodhart described these two decades as the NICE years – non-inflationary continuous expansion. The triumph for central banks was the widely accepted description of this era as the Great Moderation. This suggested that independent central bankers had delivered mankind from the age-old scourge of inflation. Central banks and supervision before the Global Financial Crisis The consensus that formed in the early period of central bank independence predominated prior to the Global Financial Crisis (GFC). In 2018, Ed Balls identified the following main features. 1. A central bank should focus on meeting a price stability objective, usually defined by an explicit inflation target. The concept of “divine coincidence” introduced by Blanchard and Gali in 2007 implied that the central bank’s focus on low and stable inflation was closely linked with keeping output at its efficient level and maintaining full employment. The central bank therefore had primary responsibility for stabilising the business cycle. Monetary and fiscal policy could operate in isolation because the former could offset much of the latter’s macroeconomic impact. Financial stability was left within the purview of supervisors and regulators, rather than that of monetary policymakers. 2.

The main argument for central bank independence is inflationary bias, the existence of which was confirmed by the high rates of inflation seen in most advanced economies in the 1970s and 1980s. Inflationary bias is the outcome of discretionary monetary policy that leads to a higher than optimal level of inflation. Two theoretical explanations were offered for inflationary bias. The first was the time, or dynamic, inconsistency of governments, and the second was governments’ efforts to introduce an “inflation tax” to reduce public debt. Time inconsistency occurs when policymakers announce that they will pursue a particular policy in the future but then follow a different one in reality because their preferences change in the meantime. The “today’s actions = tomorrow’s regrets” problem arises because time-inconsistent decision-makers value the present more than the future. The general solution to this problem is not to allow decision-makers to make discretionary decisions, but to impose certain rules on them instead. This was the conclusion reached by Kydland and Prescott in a pioneering paper published in 1977, which later won them the Nobel prize for economics. The theory evolved in two directions. In 1985, Kenneth Rogoff developed the rules argument by introducing the concept of a conservative central banker. According to Rogoff, society can sometimes make itself better off by appointing a central banker who does not share the social objective function, but instead places a larger weight on inflation rate stabilisation relative to employment stabilisation.