Gongol.com Archives: August 2025
August 25, 2025
Why you care about an independent central bank
The biggest obstacle to a real public understanding of economics is not that the subject itself is intuitively hard. The real problem is that so many of its conclusions are relatively straightforward, but the most important ones tend to be either non-obvious or downright counterintuitive. That's because at heart, economics is a study of human behavior and human beings just don't always make sense. ■ One of those important, but non-obvious conclusions is that the best possible situation is for prices to rise (but only buy a little bit) all of the time. It's easy enough to see why prices rising too fast (high inflation) are bad things. But people tend not to realize that it can be equally bad for prices to fall for a prolonged period of time (deflation). Deflationary periods, when prices fall across-the-board for too long, cause people to decide to hold off on spending so that they can get better deals later. This causes economic contraction that can be just as painful as when prices rise too fast. ■ Individually, it's hard not to like the feeling of falling prices. But spread across the scale of a population, the phenomenon becomes a huge problem. It isn't obvious that low and predictable inflation is the ideal condition, but that's one of the key assignments given to the Federal Reserve Board. ■ The Federal Reserve is charged with aiming for prices to rise gently and predictably. This leaves people best off across the board because it preserves most of the savings that they keep from year to year while very gently encouraging people to spend rather than hoard their cash. ■ Finding the Goldilocks number for inflation (not too much, not too little) and sticking to it is an incredibly difficult task. It's difficult not just in mathematical terms, but also in social science terms. Not everyone has the same incentives to cheer for the same amount of inflation at the same time. Retirees, for instance, typically want inflation to remain very low, while companies with heavy debt burdens might like a lot more. ■ That's what makes central bank independence utterly vital to an advanced economy. It's not that a central bank should be completely ignorant of politics (after all, it is acting on the most consequential of the social sciences), but there needs to be sufficient independence that the people in charge of managing the money supply are free to act without fear that they will be persecuted or punished for doing the right thing when it requires going against prevailing public opinion. ■ Again, it is not intuitively obvious that the smartest thing a government can do about inflation is to stay out of the question and leave it to professionals who are outside of their reach. But that is the right conclusion. The more credible the case that a government will leave the central bankers alone, the more confidence people can have not only in that government, but also in the money supply of that country. ■ Confidence is hugely valuable to those who have earned it -- it's expensive to procure and requires self-discipline to maintain. Once you have it, the stupidest possible decision is to fritter it away.
