Central Bank Authority and Exchange Rate Regimes
Two economists are debating the power of a country's central bank. The country in question maintains its own national currency.
Economist A argues: 'As long as a country has its own currency, its central bank always possesses the ultimate legal authority to set its own policy interest rate, regardless of any other policy choices.'
Economist B counters: 'That's incorrect. If that same country decides to rigidly fix its exchange rate to a major foreign currency, it effectively loses the power to set its own interest rate.'
Analyze the arguments of both economists. In your analysis, distinguish between the formal, 'on-paper' authority of the central bank and the practical realities of its policy choices. Conclude by stating which economist's argument is more accurate when considering only the formal, legal power vested in the central bank.
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