Central bank independence can be characterized as amultifaceted institutional design. It basically refers to the freedom ofmonetary policy makers from direct political or government influence in theconduct of policy. (Belke & Polleit, 2009,p. 528)A central bank is formed throughgovernment legislation; therefore, they both have a continuous relationship.
However, the question remains as to on what level this relationship should be.Undoubtedly not to the point where the government orders the central bankauthoritatively. Hence, it has been proven that the central bank is favourablein any economy.When government spends unwiselyresulting in huge budget deficit, which is larger than the sum of money thatwere collected from taxes or from the issuance of government debt, there wouldbe a cause for concern re inflation. In order to balance payments, thegovernment would seek to either issue more government debts or print moremoney. Nonetheless, for political reasons they would opt to print more moneyrather than issue more government debt, as a result there will be inflation.
Therefore,the only limitation to any reckless government spending is having a central bankthat is independent. If we are to give politicians thesole responsibility for both monetary and fiscal policies before or after ageneral election they would manipulate the economy by reducing the interestrate just before the election, for their own political gratification. After theelection when things start to get out of hand the citizens would eventuallysuffer from high inflation, especially when they would recklessly startprinting excess money.
Generally, people believe that if the central bank isless vulnerable to political manipulation it is likely to pursue lessinflationary policy and would behave in a way that can be predicted, therefore,it would be wiser to have an independent central bank to handle the monetarypolicy rather than the government, thus creating stronger credibility for thebank resulting in increased investment by businesses.Given that the central bank is theonly institution responsible for monetary policy, there is a possibility that itis likely to threaten the citizens of a country. Additionally, it is alsoresponsible for the printing of money, which gives it dominance over thegovernment. Furthermore, the central bank is likely to give a misrepresentationof the money supply so that it could meet its financial preferences.
Therefore,although the central bank’s aim is to regulate the country’s well-beingfinancially, various steps should be taken to prevent any financial catastrophethat may occur as a result of the bank’s selfish actions.