The economic theory of central bank independence

The article provides an overview of the theoretical literature on central b ank independence. The authors explain the problem of dynamic inconsistency in monetary policy, and show several possible solutions to the problem. The se include improving the banks' reputation, establishing a conservative cen tral banker, and using the optimal contract design. The authors show a mode l of how inflation bias may be influenced by the political cycle, and concl ude with an overview of "the new political economy" of central banking, whi ch sees central bank independence as an endogenous variable influenced by t he political game between the bank, government, voters, and lobbies.