Collection and Analysis of Historical Data - Essay Example

? COLLECTION AND ANALYSIS OF HISTORICAL DATA al Affiliation) Key words: Inflation Bias, Central Bank Background The willingness of countries to encourage their central banks to print more money, or implement policies that results in an increasing inflation rate over a period of time is called inflation bias. Governments have minimized this bias by giving their central banks a legal independence. The flat money system adoption has resulted to the present rise in the inflation rate of many countries. The rise in inflation tends to differ from one nation to the other. However, the inflation bias presence is a typical feature of the system of flat money where the monetary mechanisms are pursued with discretion. Inflation bias exists because of two reasons. First, with the discretionary sovereignty over the monetary policy conduct, nations can fund deficits of the budget by raising the seigniorage cash inflows over the non-inflationary amount. Seigniorage can be part of the maximum tax composition due to the marginal cost of every kind of taxes. To reduce the inflation bias, many nations have opted to give their central banks the legal independence. The paper therefore, analyses and discusses if nations with independent Central Banks also experience a lower inflation. Research Question Most governments and nations impose legal independence on their central banks. Their aim is to cushion the monetary policies from the political interference and from the pressure of electoral to deliver the economic growth at the long term inflationary cost expense. It is always assumed that the legal independence of central banks from the fiscal authority is crucial as it protects the economy from the debt monetization. Therefore, the paper will answer the question if the commitment of the credible government is deemed to have a reduced rate of inflation. Objective Objective 1 The objective of this research is to find out if countries and nations having independent central banks also have a reduced inflation rate. Objective 2 The objective of the research is to determine ways that governments do in order to minimize the inflation bias. Objective 3 The objective of the research is to discuss through the collection and analysis of historical data and illustrating real life scenarios from the European, UK, or American Central banks. Question Interpretation Governments have alternative institutional arrangements which they exercise the monetary policy responsibility. A common arrangement is through independent central banking. The independent central bank is considered as one of the better alternatives for the policy instrument due to their changed in the economic performance. The conventional idea behind the central bank independence is to provide a better monetary policy for the country. The question that has always gone unanswered is if nations that have employed the mechanism of independent central bank experience a lower inflation. The choice between unemployment and inflation is a political choice rather than a technical choice. There is a perspective trade-off between the stabilizing the economy and lowering the inflationary bias. However none of the dimensions have been put into consideration. The inflationary bias evidence has been scarce this is because it requires identifying the inflation rates. Literature Review The independence of central banks has been the conventional mechanism in countries that are developed. For instance, in Europe the nations have confined their powers to surpass the power of central banks through the parliament declaration (“Central Bank Independence and Inflation”, 2013 ). The nuclear option was never implemented, but it led to a greater incentive for the consensus among the official families. The independence of central banks was much stronger in 1990s. New Zealand had an extreme form of central bank independence when the country was the love for free market reformers. The Reserve bank president was appointed to maintain the rate of inflation between zeros and two per cent, that gave him a full independence (Lohmann and Susanne, 1998). The approach of the New Zealand to the monetary policy was a disaster; this pushed the country into unplanned recession. These versions were used in most countries that are developed. The key elements for practicing central bank independence included the inflation targeting, deregulation of the comprehensive financial, abandoning the fiscal policy of active countercyclical, and adjustment of interest rate. The above forms gave the central banks an independence form (Lohmann, and Susanne, 1992). The inflation target is a direct independence of central bank repudiation. This is because it facilitated the fiscal policy and also underscoring the idea that the greatest financial catastrophe in history happened in the strong central bank independence era. This resulted in Great Moderation cause due to a combination of financial deregulation and central bank independence. According to Stephen Lathrop, in inflation and central bank independence not every increase in price is inflationary. Normally, inflation is caused by a lot of money purchasing very few goods. But the rise in prices can also be caused due to rigged market; as in the case of oil (Lathrop, Levy-Yeyaty, and Eduardo, 2001). The relationship has not been well explained by the previous economic conditions. According to James Kroeger, countries with independent Central Banks also have a lower inflation. He points out that the financial catastrophe that happened when the central bank independence was strong was due to the combination of the financial deregulation and central bank independence (Kroeger, Leeson and Peter, 2008). The monetary policy was very crucial to be abandoned to the central bankers alone. Additionally, not every rise in inflation is inflationary. This is because; most of the developed countries do have a problem of high inflation rates. The US government created double digit inflation within a specified segment of the employees; likewise a five per cent of the working citizens experienced the disinflation due to illegal immigration, unemployment, and outsourcing. According to the Bundesbank, every independent Central bank that is confronted with inflationary shock has to find ways of reducing the inflation level (Leeson and Peter, 2008). For instance, the Bundesbank knew from the beginning that it was facing a rising inflation. At that point the bank tightened their money supply and increased their interest rate to fifteen per cent. It is likely that his monetary and fiscal policy will be coordinated in Europe than in Germany. Immediate aftermath for the employment and growth tend to be unfortunate this is because it is likely possible that scenarios that need national fiscal policies, the independent central banks will pursue monetary mechanism to attain a low inflation rate (“Independence, and the Credibility of Monetary Policy” 2003). More than half a decade after the reform programs implementation in the previous Soviet Union it is possible start evaluating lessons from the first transition processes. The discussion section examines important relationship on the structure of central bank and inflation and also the effect of e inflation on the growth of an economy. The section develops indices of CBI (Central Bank Independence) for the economies under transition. Discussion One of the key axioms of macroeconomics is the growth rate sustainability of a country’s money stock exceeding the production of services and goods. The production of the services and goods leads to a rising and high inflation rates. The axiom was well drafted by Friedman where he said the increase in price levels is everywhere and always a monetary element. The history of economy is filled with nations that faulted on their axiom. An example is Zimbabwe, which saw the country raising their inflation rate from 24000% to 89.8 trillion percent (Keefer, Philip and David, 2003). The ability of governments to willingly make their central banks to print a lot of money or implement the policies resulting in a higher rate of inflation is called the inflationary bias. The inflation bias has been minimized by governments by giving the central banks the legal independence. The question can be answered properly by providing country specific elements of their central bank independence. The majority of economists have come up with Central Bank Independence from the various legal benchmarks (Keefer, Philip, and David, 2002). Research finds out that the advanced countries having high leveled central bank independences also experience a lower inflation from 1955 to 1988. The figure below shows the negative relationship of the research question. Index of Central Bank Independence vs. the Average Inflation In the figure below it is shown that inflation has sharply reduced globally since mid-1990s. World CPI inflation While the two charts below show that the global inflation rapid descent was as a result of development of developing markets and the emerging markets. CPI inflation in Advanced Countries CPI Inflation in Developed Countries In the countries that are advanced, the slowing happened much earlier at the beginning of 1980s. The decline in inflation globally was as a result of many factors since the end of 1980s (Jacome, Luis, and Francisco, 2005).This included a stronger commitment to stability in prices, higher productivity growth rate, and the globalization forces that rose to the competition and enhanced the product and labor market flexibility. The rising independence of central bank is another crucial factor in the fall in inflation globally as outlined in the table below Independence Advanced Economies 1980-1989 2003 Net Change Weak Independence 13 8 -5 Moderate Independence 8 5 -3 Strong Independence 0 13 13 From the table above it is evident that there was a rise in independence of central bank between 1980 and 1989 and also in 2003. This trend was evident in advanced economies. The many reforms that facilitated the independence of the central banks happened in 1990s and were responding to the inflation higher rates. The shift towards higher independence of the central bank enabled an explanation the lower inflation in the United States (Iversen and Torben, 1998). The Central Bank Independence recorded an increase in the USA. However, the shift from the weak independence and moderate independence to a stronger independence occurred since nations that were in European Union thereby becoming European Central Bank members. Due to the Maastricht treaty, the European Central Bank is very independently strong. However, despite the rising trend in Central Bank Independence, the Federal Reserve is still dependent, according to the table above; the inflation rate of the United State has slowed between 1970 and 1980. This shows that the Central Bank Independence might be important but not sufficient to yield a proper performance of inflation over time. However, the independence of central banks is important in explaining the fall in rates of inflation since1980 (“International Monetary Fund” 2006). Conclusion The ability of governments to willingly make their central banks to print a lot of money or implement the policies resulting in a higher rate of inflation is called the inflationary bias. The inflation bias has been minimized by governments by giving the central banks the legal independence (Hayo, Bernd and Stefan Voigt, 2008). The question was answered properly by providing country specific elements of their central bank independence. The majority of economists have come up with Central Bank Independence from the various legal benchmarks. The research finds out that the advanced countries having higher level central bank independences also experience a lower inflation from 1955 to 1988. The Central Bank Independence recorded an increase in the USA (Hayo, Bernd and Carsten, 2002). However, the shift from the weak independence and moderate independence to a stronger independence occurred from nations that were in European Union thereby becoming European Central Bank members. Due to the Maastricht treaty, the European Central Bank is very independently strong. However, despite the rising trend in Central Bank Independence, the Federal Reserve is still dependent, according to statistics the inflation rate of the United States has slowed between 1970 and 1980. This shows that the Central Bank Independence might be important but not sufficient to yield a proper performance of inflation over time (Hielscher, Kai and Gunther Markwardt, 2012). The main finding of the relationship shows that there is a negative correlation between the inflation and the Central Bank Independence. Therefore, countries that have more CBI have a lower inflation rate. The monetary policy was very crucial to be abandoned to the central bankers alone. Additionally, not every rise in inflation is inflationary. This is because; most of the developed countries do have a problem of high inflation rates. The US government created double digit inflation within a specified segment of the employees; likewise a five per cent of the working citizens experienced the disinflation due to illegal immigration, unemployment, and outsourcing Recommendation It is not surprising that the rise in Central Bank Independence would result in a less accommodative monetary policy and thus lower inflation (Henisz, and Witold, 2004). Therefore, protecting the government from the political interference means a lower tolerance to the created inefficiency. Less obvious, is the outcome that financial consideration outlines the long run monetary policy although the commitment is limited and there is no institution that is designed to dominate others. Consequently, Central Bank Independence needs to involve protection from the pressure of politics. It should also be protected from indirect influence via the endogenous position of the world like the public debt level. The targeting inflation nations appear to be developed to fulfill such purposes which may assist in explaining their effectiveness and popularities in countries with Central Bank Independence (Hallerberg, Mark, and Scott, 1998). Reference 1. Hallerberg, Mark, and Scott Basinger. 1998. Internationalization and Changes in Tax Policy in OECD Countries: The Importance of Domestic Veto Players. Comparative Political Studies 31 (3): 321-352. 2. Henisz, Witold. 2004. Political Institutions and Policy Volatility. Economics & Politics 16 (1): 1-27. 3. Hielscher, Kai and Gunther Markwardt. 2012. The role of political institutions for the effectiveness of central bank independence. European Journal of Political Economy 28 (3): 286-301. 4. Hayo, Bernd and Carsten Hefeker. 2002. Reconsidering central bank independence. European Journal of Political Economy 18 (4): 653-674. 5. Hayo, Bernd and Stefan Voigt. 2008. Inflation, Central Bank Independence, and the Legal System. 6. 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