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Debt, Inflation and Central Bank Independence

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  • Fernando Martin

    (Federal Reserve Bank of St. Louis)

Abstract
When governments trade-off maximizing general welfare with maximizing their own expenditure, the degree of central bank independence has implications for inflation, taxes and debt. Making the central bank more independent implies that, for any given level debt, inflation and taxes decrease, while debt accumulation increases. In the transition, as debt increases, inflation and taxes revert to their pre-reform levels, due to the higher financial burden. In the long-run, only debt varies significantly. Adding an explicit monetary target does not alter this result, but may still affect how policy responds to cyclical shocks. The model suggests that the debt increase and inflation reduction experienced in the U.S. and several other developed countries in the early 1980s is the combined outcome of increased central bank independence and lower tolerance for inflation by agents.

Suggested Citation

  • Fernando Martin, 2012. "Debt, Inflation and Central Bank Independence," 2012 Meeting Papers 1019, Society for Economic Dynamics.
    • Handle: RePEc:red:sed012:1019
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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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