Why do politicians decide to delegate to central banks

Finally I found some paper which helps me understand why do politicians give up powers to Central banks? This one is a fairly technical one from Christopher Crowe of IMF. Though he backs it up with some interesting case studies. It is also focused on goal independent central banks and not central banks in general. There are two ways by which you check independence:

  • Goal independent means central banks can decide what and how to operate mon policy. Some say ECB is goal independent and others add Fed as well.
  • Instrument independent mens governemnt decides what to do and Central Bank decides how to do. Most Central Banks are instrument independent.

In nutshell politicians delegate monetary policy to goal independent central banks because it allows them to remove conflict amidst political parties. Otherwise political parties fight over what should the Central Bank do and try and influence it.

The motive for delegating the monetary policy decision to a fully (goal-) independent central bank is that it removes the intracoalition conflict over monetary policy from the political arena. I derive the conditions under which delegation will occur. In equilibrium, the cost of coalition formation depends upon the relative sizes of the factions within each coalition. Since e¤ective lobbying strength depends on faction size (because larger factions have lower per-member lobbying costs), equal-sized factions (with equal chances of winning) will invest heavily in lobbying for their preferred outcome. The contest will therefore be costly for the coalition as a whole, motivating both sides to take monetary off  the table. By contrast, if one faction dominates in terms of size, then lobbying strengths are clearly mismatched, the likely victor in the policy dispute is clear, and no faction will commit significant resources in the dispute. Incentives to delegate will be minimal.

And keeping mon pol off the table actually enhances powers as it helps them focus on other areas and not being worried about opposing parties trying to control mon policies .

One could argue that the independence enjoyed by goal-independent central banks (GICBs) is particularly striking given the political sensitivity of their core role . the conduct of monetary policy. However, this political sensitivity could explain the decision to delegate. Because monetary policy is contentious, it can split otherwise homogeneous political coalitions. Taking monetary policy off the table makes it easier for these political actors to effectively combine to control policy with respect to other key issues. Far from being constrained, politicians who decide to delegate may see their overall freedom of action enhanced.

It also points to case studies of Bundesbank, Netherlands Central Bank (how politicians formed a coalition as mon pol was off the table). Some parties even tried to gain more authority over Bundesbank as there was little conflict in economic policies with others. On the other hand in UK there was no difference amidst politicians over economic policy and as a result Bank of England was hardly independent. Only when differences arose it was decided to make it more independent (but again it is just instrument independent). Then there is experience of South Africa where the Bank was granted goal independence as there was conflict amidst politicians.

These are all very different and interesting insights. You have a goal independent central bank when politicians fight over economic policy. If politicians have similar econ policies you end up with a not-so independent central bank.

It is often said RBI is not as independent. Though there are many reasons one reason could be that our political parties hardly have any economic agenda. The elections are fought on all kinds of reasons and economics plays a very small role. Moreover, whichever party has used economics as the agenda, it has lost the elections (R’ber the BJP 2004 election campaign of India shining). Is RBI/Monetary policy ever a point of discussion amongst our political parties? Barring finance ministry I doubt it.

So would difference in economic policies lead to a more independent RBI? That is a research question worth exploring for sure.

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