A central bank is an organization responsible for managing banking activity.

Within the USA the

central bank is the Federal Reserve, or 'the Fed'. Other countries have central banks as well.
Their roles are similar, but they may have different objectives.

The central Bank achieves greater independence from parliament and the President through a
structure that insulates the governors from Political pressure (Appointment to long term to five
years in Tanzania,14 years in USA). Non renewable terms of 14 years allows Governors to focus
on long term goals, without having to worry about gaining the political influences for
reappointment.

The Central Bank finances its own operation without the needs of parliament appropriations. The
Central Bank funds its own operation through the profit from trading and holding treasury
securities and through revenue from discount loans so it does not depend on parliament for its
funding. The independence allows the central bank to pursue long term economics goals which
can conflicts with short term political goals in particular the goal of price stability.

1. The Importance of Price Stability

Price Stability implies that the Rate of Inflation, which is measured by the rate of increase of the
National Consumer Price Index, has to be kept as low as possible, optimally within a longer-term
average range of 0-5% (percentage change on the previous year). With a high rate of inflation,
increases in wages and salaries cannot keep pace with the resulting erosion of purchasing power,
and, hence, there will be decreases in real incomes for a large part of the population, which may
result in corruption, an expansion of the informal sector, social friction, increased crime, and as a
consequence of these factors, a decrease in economic efficiency. Furthermore, a high rate of
inflation is an incentive for currency substitution and capital flight, it leads to an unplanned
redistribution of income and wealth, mostly in favour of the rich, and, in general, it adversely
affects decisions on consumption, saving, borrowing, and investment in productive capacity, by
increasing uncertainty about future prices. Excessive inflation is also an impediment for
achieving interest and exchange rate stability, which is very important for facilitating smooth
economic development. Therefore, a combination of these factors could seriously impede the
timely achievement of the Financial and Economic Restructuring Program. In this connection, it
has to be stressed again that Price Stability is the decisive cornerstone of a successful economic
policy geared towards sustainable medium- and longer-term economic growth. In other words,
economic growth in the Country will be severely curtailed in the medium and longer term, if
inflation continues to prevail at a high rate.

2. Prerequisites and Limits of an Effective Monetary Policy

To achieve this objective, the Bank formulates and implements Monetary Policy, by using
instruments, such as Refinancing Policy, Minimum Reserve Policy, Open Market Policy,
Foreign Exchange Interventions, and other instruments. The Ultimate Objective of Price
Stability, however, can only be realized over time, if there are well-coordinated Monetary,
Fiscal, and General Economic Policies, i.e., there has to be a concerted national effort. Monetary
Policy, by itself, cannot achieve Price Stability, no matter how strict a Monetary Policy Stance
the BOT is pursuing, it can only dampen inflation to some degree, depending on the inflationary
pressures emanating from Fiscal and General Economic Policies. Furthermore, the attainment of
the Monetary Policy Objectives has to be facilitated by a continued application of market-
oriented policies in the financial sector (the creation and maintenance of an efficient payments
system is included here), the public sector, the industrial sector, the agricultural sector, and the
external payments area.

The big advantage to independence is that it gives the central bank the cover to work towards
economic goals even if they are unpopular in short run