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When central banks operate free of political pressures, they are free to
make policy decisions based on economic conditions and the best available data
on economic performance, rather than short-term political considerations
imposed by elected officials or political parties. The U.S. Federal Reserve
operates with a high level of political independence, even though it is
accountable to Congress. Federal Reserve board members are presidential
appointees but have staggered terms to make it more difficult for a president to
load the board with favorite appointees. When central banks lack this
independence, monetary policy becomes subject to political pressures. Harvard
economist Greg Mankiw, for example, writes that central bankers that lack
political independence may manipulate monetary policy in a manner favorable
to the political party in power.
Disadvantage: Time Lag
The Federal Reserve and other central banks can use monetary policy
to achieve low inflation in the long run and affect economic output and
employment in the short run. The Federal Reserve Bank of San Francisco
reports that these goals sometimes conflict. Reducing interest rates to expand
the money supply and stem rising unemployment rates during a recession, for
example, could spark future inflation if monetary policy remains expansionary
for too long. The best monetary policy seeks to strike a balance between these
short- and long-term goals.
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