The economic theory of central bank independence

The article provides an overview of the theoretical literature on central bank independence. The authors explain the problem of dynamic inconsistency in monetary policy, and show several possible solutions to the problem. These include improving the banks' reputation, establishing a conservative central banker, and using the optimal contract design. The authors show a model of how inflation bias may be influenced by the political cycle, and conclude with an overview of "the new political economy" of central banking, which sees central bank independence as an endogenous variable influenced by the political game between the bank, government, voters, and lobbies.