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Debt, Inflation and Central Bank Independence

Increasing the independence of a central bank from political influence, although ex-ante socially beneficial and initially successful in reducing inflation, would ultimately fail to lower inflation permanently. The smaller anticipated policy distortions implemented by a more independent central bank would induce the fiscal authority to decrease current distortions by increasing the deficit. Over time, inflation would increase to accommodate a higher public debt. Alternatively, imposing a strict inflation target would lower inflation permanently and insulate the primary deficit from political distortions.

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