The U.S. monetary policy framework that exists today has proven reasonably good at laying the foundation for price stability that is a necessary condition for sustaining growth at full employment over time. Although the world of central banks is still characterized by substantial diversity in the regimes they operate under, the actions of central banks reveal on average a much greater appreciation of the benefits of price stability and a greater willingness and ability to achieve it. These gains in inflation performance have been supported by a range of factors. Luck in the form of smaller shocks, technological change, other policy actions that contributed to more rapid economic integration and greater flexibility in how economies adapt to change, and greater financial resilience have all contributed to this improvement in inflation outcomes. But monetary policy seems likely to have played a decisive role, and part of that improvement reflects the sustained improvement in the institutional framework within which central banks operate. Credibility, particularly in monetary policy, takes time to establish, and can be easily compromised. It comes not just from what you say you will do as a central bank, but from what you actually do over time, and the results of those actions. It depends importantly on the competence and courage of those asked to lead central banks, on their capacity to be flexible and creative in response to our rapidly changing world, on their ability to communicate effectively and to acknowledge uncertainty.
The institutional arrangements that seem most relevant to monetary policy credibility and competence involve the degree of independence afforded the central bank, the design of the mandate or objectives given the central bank, the regime or instruments adopted by the central bank to pursue that mandate, the structure of the decision making process, and the degree of communications and transparency. I want to talk about this broad complement of the institutional foundations of a credible central bank, and I’ll do so in part by talking about the history of the central bank of the United States. For reasons that are simple and compelling, independence is a critical part of the foundation for a credible central bank. Independence comes in many forms, and some of the most important dimensions of independence are hard to discern from the legal underpinnings or the formal structure of the institution. Central banks with many of the formal or legal attributes of independence can make bad policy choices. Central banks without formal independence can make good policy choices and achieve sustained improvements in macroeconomic outcomes. What does independence mean and how do we know it when we see it? Why is it important and how does it affect the quality of monetary policy choices and outcomes? In its most basic sense, independence is the freedom to pursue a defined monetary policy objective without consideration of political or private interests, and without fear of subordination to other economic policy objectives.