Central Bank Independence: Optimal Conservativeness and Optimal Term Lengths

Abstract

In many economies, the legal term length of office of central banker is specified by a constitutional rule set by the Government. However, this rule is effective as long as the central banker pursues credibly independent policies, and as long as the Government commits to the rule. On the other hand, the policies of the central banker must also be sufficiently flexible to respond to output shocks. In this paper, we determine that the Government can obtain the balance between credibility and flexibility by appointing an optimally weight-conservative central banker who implements time-consistent policies for an optimal period of time.