How the European Central Bank and Other Independent Agencies Reveal a Gap in Constitutionalism: A Spectrum of Institutions for Commitment

Today’s central banks wield extraordinary powers, both monetary and regulatory, and with a capacity to substitute for elected governments tempted to pass the buck. Debates about central banking’s powers and legitimacy barely touch, however, on whether and how monetary independence fits with the values that drive constitutionalism. It turns out that, for modern economies using fiat money, independence is a corollary of the higher level separation of (fiscal) powers between the legislative and executive branches. Even though independence is necessary, it needs to be carefully constrained by a “money-credit constitution.” Those general arguments, applicable in liberal democracies, do not carry across cleanly to the euro area. A principled case can be made for the ECB’s mandate being specially tight, but that is in tension with its de facto role as the emergency economic actor for the euro area. Facing up to that will be necessary sooner or later.

Trinity Strikes Back

Monetary independence is at the core of the macroeconomic policy trilemma stating that an independent monetary policy, a fixed exchange rate and free movement of capital cannot exist at the same time. This study examines the relationship between monetary autonomy and inflation dynamics in a panel of Caribbean countries over the period 1980–2017. The empirical results show that monetary independence is a significant factor in determining inflation, even after controlling for macroeconomic developments. In other words, greater monetary policy independence, measured as a country’s ability to conduct its own monetary policy for domestic purposes independent of external monetary influences, leads to lower consumer price inflation. This relationship—robust to alternative specifications and estimation methodologies—has clear policy implications, especially for countries that maintain pegged exchange rates relative to the U.S. dollar with a critical bearing on monetary autonomy.

Policy Trilemma and Interest Rate Behavior in Nigeria

Policy makers face trade-off in dealing with exchange rate management, monetary independence and concerns about capital mobility simultaneously. This study empirically examines the effects of Nigeria's trilemma policy path on interest rate using data spanning from 1997:Q1 to 2017:Q3. It equally incorporates the role of external reserves in buffering these effects. Stationarity of the series were ascertained with Zivot-Andrew (ZA) structural break unit roots test technique, while the bounds test cointegration approach was used to confirm the cointegrating properties of the variables. We found that capital mobility has significant effect on interest rate in the long run baseline model and could also be successfully buffered with external reserves to reduce interest rate. Additionally, our results show that although exchange rate stability and monetary independence do not independently affect interest rate, but their interaction with external reserves does. This implies that external reserve serves as an effective buffer if appropriately employed by the monetary authorities. The trilemma policy can be used to optimally reduce interest rate. Also, external reserves could serve as a tool for economic stabilization with appropriate combination with other relevant policy variables.