## Central Bank Independence and Macro-Prudential Regulation

_IMF Working Papers, April 1, 2012_

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## Bibliographic details
- Authors: Fabian Valencia, Kenichi Ueda
- Published: April 1, 2012
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475502916.001

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### Summary
- Paper examines optimal institutional arrangements for agencies conducting macro-prudential regulation and monetary policy.
- Main mechanism identified: when a central bank is responsible for both price and financial stability, a new time inconsistency problem can arise.
- Ex-ante, the central bank chooses the socially optimal level of inflation. Ex-post, the central bank may choose inflation above the social optimum to reduce the real value of private debt.
- This inefficient outcome occurs when macro-prudential policies cannot be adjusted as frequently as monetary policy.
- The time inconsistency result holds even when the central bank is politically independent.
- The paper extends the analysis to include political pressures in the spirit of Barro and Gordon (1983): if either the macro-prudential regulator or the central bank (or both) are not politically independent, separation of price and financial stability objectives does not deliver the social optimum.

### Key findings
- A central bank charged with both price and financial stability faces an ex-ante/ex-post conflict that can lead to inflation above the social optimum to inflate away private debt.
- Asymmetric adjustment frequency between macro-prudential tools and monetary policy (macro-prudential tools less adjustable) is a crucial condition for the identified inefficiency.
- Political independence of the central bank alone does not prevent the inefficiency if the institutional design places both objectives in the central bank’s mandate.
- Lack of political independence in either the macro-prudential regulator or the central bank undermines the effectiveness of separating price and financial stability objectives.

### Policy implications and recommendations
- Institutional design should account for the potential time inconsistency when assigning both price and financial stability mandates to a single central bank.
- Consideration needed for the relative adjustability (frequency and flexibility) of macro-prudential tools versus monetary policy instruments.
- Political independence of institutions matters, but independence of just one institution (central bank or macro-prudential regulator) may be insufficient to guarantee socially optimal outcomes.
- Separation of objectives (price versus financial stability) is not guaranteed to produce the social optimum unless institutional arrangements address both time inconsistency risks and political pressures.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/central-bank-independence-and-macro-prudential-regulation-25872_