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Argentina Abandoned its Currency Board

One result was a resurgence of inflation. Another variation on the delegation of monetary policy is that adopted by many countries in Europe. They decided to abandon their currencies and their monetary autonomy in favor of a new currency called the euro. Monetary policy is run by the European Central Bank, which is highly independent. Independent central banks are better able to resist political pressure, so countries that had previously had weak central banks saw a significant advantage in adopting the euro. Abandoning one’s currency in favor of a new currency, as occurred throughout Europe, seems like a particularly powerful way for a country to commit to a new monetary regime. It is worth remembering, though, that no monetary system is cast is stone. Just as Argentina’s currency board collapsed despite its apparent credibility, so too could a country decide to abandon the euro and reestablish its own currency. Indeed, following fiscal problems in several countries in Europe (most notably Greece, Portugal, and Ireland), there has been some speculation that some countries might eventually choose to do just that. Independent Monetary Authorities Hyperinflations arise when the central bank is weak and unable to resist the pressures put on it by others—notably politicians—to use monetary policy for other purposes. Monetary authorities must be able to “just say no.” This suggests that monetary authorities will be able to do a better job if they are independent of other branches of government. Economists have studied the relationship between measures of the independence of a country’s central bank and the inflation rate in that country. Economists Alberto Alesina and Lawrence Summers examined both political and economic independence of the monetary authority. By political independence, they meant the process of appointing the leadership of the central bank and the role of government officials in the conduct of monetary policy. By economic independence, they meant the extent to which the monetary authority is under pressure to finance the government’s budget deficit. Figure 11.11 “Central Bank Independence and Inflation” displays data from their research. The horizontal axis shows annual inflation, and the vertical axis is their index of central bank independence, with higher numbers indicating a more independent central bank. The data are averaged over the period 1955–1988. Each point in the figure refers to a particular country. Switzerland and Germany both receive very “high” central bank independence ratings of 4 and have relatively low average inflation. Spain, in contrast, has the second lowest measure of central bank independence and has the highest inflation rate in the study.

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