Essay Example on Governments are required to choose between currency stability and national Economic

Advanced industrialized countries therefore favor floating exchange rates because they are unwilling to forsake their national economic autonomy and also not willing to pay such costs in order to sustain fixed exchange rates Hence it depends on how governments view the tradeoff between fixed exchange rates and domestic economic autonomy Consequently the countries that desire domestic economic autonomy have to consider independent central banks in order to maintain low inflation As inflation carries potential large costs in terms of higher unemployment and less economic growth society can be benefitted by monetary policies that maintain low inflation consistently In this respect independent central banks come into play Most governments are unable to achieve and maintain low inflation and thus establish credible commitment mechanisms for this purpose in the form of fixed exchange rates and independent central banks In theory both mechanism provide credible commitment towards maintain low inflation but only independent central banks can do actually in practice Firstly Independent central banks can decide freely what economic goals to pursue and how to use monetary policies to pursue such goals without the interference of governments Secondly fixed exchange rates cannot solve time consistency problem Independent central banks solve this problem by preventing the governments to pursue short term objectives They take the use of monetary policy completely out of control of politicians who now cannot set monetary policy for their short term political aims In this way an independent central bank ensures low inflation and strong economic growth Therefore a country which wants to retain domestic economic autonomy consider only central bank independence because still the government does have the power over exchange rates system Exchange rates and monetary policy options can be explained by three society based models of monetary and exchange rates politics  

Partisan model It assets the same assumptions as electoral model with one distinction It argues that different political parties have different macroeconomic objectives Those which want to limit inflation use monetary policy in line with floating exchange rates while other use fixed exchange rates in order to reduce unemployment 3 Sectoral model this model assumes that interest groups import competing producers export oriented producers non trade goods producers and the financial services industry preferences shape exchange rates and monetary policies Some prefer strong currency and some weak currency whilst some other groups fixed exchange rates and some prefer floating exchange rates These groups lobby the government on the basis of their preferences they possess Internationally the countries have abandoned the use of monetary policy and have placed monetary policy into the hands of officials of independent central banks who are completely secured against any political push and pull Often the groups of central banks work together in a coordinated way in order to maintain price stability and strong economic growth of the countries