Central Bank Independence at Low Interest Rates

This paper constructs a new measure of political pressure on the Federal Reserve from textual analysis of Fed Chairs’ testimonies at Humphrey-Hawkins congressional hearings, and documents that the use of non-traditional monetary policy instruments at the effective lower bound (ELB) led to increased political criticism that predicts legislative actions threatening central bank independence. A model is developed in which the probability of the monetary authority’s future loss of independence is increasing in the use of non-traditional instruments, leading to attenuated monetary responses and higher inflation volatility. The attenuation can be mitigated under an institutional framework with clearly defined targets where the central bank is evaluated by how efficiently it achieves its goals.

Benjamín García | Macro Paper Warehouse

Central Bank Independence at Low Interest Rates