CENTRAL BANKS

The Central Bank is a financial institution charged with several different functions, the most important of which is managing a country's monetary policy. In addition, central banks typically manage a government's debt, they participate in the formulation of exchange rate policy, together with the government, and in many countries they are the principal regulator for the financial sector. Modern central banks were first developed during the late seventeenth century, most notably with the foundation of the Bank of England in 1694. While many major central banks before 1945 were privately owned, today central banks operate as agencies of government. Recently, there has been much debate over the extent to which central banks should be independent from political control when they set monetary policy. During the post-war period governments in many OECD countries retained the authority to intervene with or override central bank decisions. This was a provision seen as a necessary corrective to the perceived failure of policies pursued by several central banks during the 1930s. Since the 1980s, with the increasing popularity of rational expectations models of monetary policy and the perceived post-war success of independent central banks like Germany's Bundesbank, it has become increasingly popular to emphasize the benefits of making central banks independent from day-to-day political interference. This intellectual shift has helped lead to reforms of central bank statutes in numerous countries, while also influencing the development of the European Central Bank, which has a very high degree of legal independence. Political scientists have begun to examine a number of issues related to this debate, asking whether de jure independence will only result in de facto independence in certain types of political systems, whether independence can only result in both low inflation and low unemployment if it is accompanied by centralized wage-bargaining institutions, and more generally how partisan political considerations influence central bank policy.