. independence refers to the “ how to ” achieve its policy objectives : a central bank is free to make decisions about the tools it employs, subject to legal constraints that are set out in its charter. [ 6 ] the central bank ’ s objectives – the “ what to ” achieve – are determined by the government, while the central bank may enjoy discretion with respect to the clarification of its objectives. central bank independence reduces the time inconsistency problem of monetary policy as well as the risk of fiscal and financial dominance. a policy is time inconsistent if an action, optimally planned today for tomorrow, is not optimal anymore when tomorrow arrives. [ 8 ] if a central bank has announced a low inflation rate, it may be tempted to depart from this announcement. surprise inflation could generate a positive output effect – but at the risk of losing credibility. additionally, if fiscal policy is weak, there can be the temptation to keep interest rates low for longer in order to generate seignorage revenues. similarly, policy decisions related to financial stability require independence. as vulnerabilities in the financial system build up during good times, macroprudential authorities should act early on in a preventive manner. sufficient capital buffers need to be generated that can absorb losses in times of crisis. however, authorities may act too late or too little if they fear negative short - term - implications for credit growth or bank profitability. in the medium - to longer - term, insufficient buffers in the financial system can threaten fiscal stability by forcing the public sector to intervene and absorb losses in times of crisis. this inaction bias can be remedied by assigning the task to safeguard financial stability to an independent authority. what are current challenges? and could central bank independence be at risk? i see three main reasons why central bank independence may move into the focus of public policy discussions : first, inflation is expected to remain comparatively high over the next couple of years. the past decade has witnessed relatively low and stable inflation across advanced economies ( graph 1 ). yet, more recently, demand and supply shocks have pushed inflation well above central banks ’ targets ( reis 2022b ). according to the most recent projections by the ecb ( european central bank ), inflation will return to target only by the year 2025. [ 10 ] and even if actual inflation rates decline, perceived inflation – notably in terms of higher energy prices – will remain at an elevated level. some structural features of the global

, central bank independence as well as the primary objective of the european central bank ’ s monetary policy are enshrined in the treaty of the functioning of the european union. see also https : / / www. ecb. europa. eu / ecb / orga / independence / html / index. en. html. 19. see arnold et al. ( 2020 ), bayoumi et al. ( 2014 ), or tucker ( 2018 ). 20. for a discussion on the features of financial cycles, see deutsche bundesbank ( 2019 ). 21. see https : / / www. ecb. europa. eu / home / search / review / html / price - stability - objective. en. html. 22. see edge and lliang ( 2020 ) for an analysis on the governance structure of macroprudential policy, including the role of central banks, in the context of decisions on the countercyclical capital buffer. 23. see buch, vogel and weigert ( 2018 ) for a description of the policy cycle linking policy objectives, indicators, and policy evaluation. houben, van der molen, and wierts develop a similar structure in the context of macroprudential policy. 24. for a discussion of decision - making in times of radical uncertainties, see kay and king ( 2020 ). 25. see shiller ( 2019 ). 26. see brunnermeier ( 2021 ). 27. this can include experts from other professions such as sociology or philosophy ( deaton 2022 ). 28. for details on the ecb ( european central bank ) strategy review see https : / / www. ecb. europa. eu / home / search / review / html / index. en. html. 29. see https : / / www. youtube. com / watch? v = tdlyuftudhe.