PROF 4- SG 7

Lapuz, Dhavevohrah Zam M./ BSBA 3B

Learning Activity 1:
1. What is central bank independence?
The concept of central bank independence, which holds that central banks
should be free from political influence, is new. The central bank was once the
government's bank, after all. First the king or emperor, later the democratically elected
congress or parliament, were served by it. Politicians hardly ever relinquish control of
anything, much less anything as crucial as monetary policy. But in the 1990s, the
central bank became independent of the finance ministry in almost every advanced
economy government that hadn't done so before. In 1993, the Banque de France
became autonomous. In 1998, the Bank of England and the Bank of Japan lost their
political control. Additionally, the new European Central Bank has been independent
from its opening on July 1,1998.
2. What is policy framework?
Today's central banks have a large list of goals, including stable interest and
exchange rates, strong growth, low inflation, and low unemployment. Central bankers
must be autonomous, responsible, and effective communicators in order to achieve
these goals. What we'll refer to as the monetary policy framework is comprised of these
characteristics taken together. To clear up any confusion that may develop during the
central bank's activity, the framework was created. Low inflation is a simple objective to
set, but there are numerous ways to measure inflation. Whichever measure is chosen, it
must be used consistently by the central bank. The anticipated actions to take when
objectives clash are also made clear by the monetary policy framework. Simply put, it is
impossible for politicians to accomplish all of their goals at once. Aside from times of
crisis, they only have one tool at their disposal: the interest rate. However, it is hard to
accomplish a long list of goals with just one tool. Interest rates are not stable if they
frequently fluctuate. More significantly, increasing the interest rate means lessening the
amount of credit and money available, thereby impeding growth. So, maintaining low
and stable inflation might sometimes conflict with the objective of averting a recession.
3. What is policy trade-offs and credibility?
The tradeoff between inflation and growth is one that central bankers have to
make every day. Central bankers must make their priorities clear because policy goals
frequently conflict. The public needs to understand if policymakers are primarily
concerned with price stability or if they are prepared to tolerate a slight increase in
inflation in order to prevent a downturn in economic activity. Furthermore, the general
public should be aware of how interest rates and currency stability are taken into
account when making policy decisions. By limiting the central bankers' discretionary
power, this crucial component of the policy framework makes sure they will carry out the
tasks that have been given to them. As a result, it plays a crucial role in the
communication duties of the bank.
Establishing credibility for policymakers is aided by a well-designed policy
framework. Everyone must have faith in central bankers for them to carry out their
commitments if they are to succeed in their goals. This is particularly crucial for
preventing high inflation. The main cause is that most economic choices are made
based on anticipated inflation in the future. When we looked at how interest rates are
set, we discovered that the nominal interest rate is equal to the real interest rate plus
anticipated inflation. In the same way, decisions on prices and wages. Prices are
determined by businesses in part based on anticipated inflation rates. They base
compensation agreements with employees on anticipated inflation in the future. Prices,
salaries, and interest rates will all rise in direct proportion to people's predictions of
future inflation.