CENTRAL BANK INDEPENDENCE AND INFLATION TARGETING - MONETARY-POLICY PARADIGMS FOR THE NEXT MILLENNIUM

An expanding body of literature holds two truths about monetary policy to be self-evident: Effective central banks must be independent from undue political interference, and they would do well to target the rat e of inflation directly. The genesis of this literature may be found i n the concern about the effective use of the significant power wielded by central banks around the world, and in the response to a pivotal a nd turbulent period in economic history. The marked rise in the level and variability of inflation following the oil price surges of the 197 0s led many to question the Fed's and other central banks' commitment to a low and stable inflation rate. This article takes a critical look at the theory of inherent inflationary bias and the proposed solution s to the bias, focusing particularly on mechanisms for ensuring centra l bank independence and on inflation targeting. It then examines the r obustness of the empirical results that are often used to support the validity of the solutions.