Central Bank Independence: An Update of Theory and Evidence

Abstract

This paper reviews recent research on central bank independence (CBI). After we have distinguished between independence and conservativeness, research in which the inflationary bias is endogenised is reviewed. Finally, the various challenges that have been raised against previous empirical findings on CBI are discussed. We conclude that the negative relationship between CBI and inflation is quite robust.

Comparison of Central Bank and Judicial Independence

“…An independent central bank is a mechanism to solve the problem of inflation bias of discretionary policy. Appointing a central bank which is independent of the political authority, (one which can set policy without political restrictions and interference), and more "conservative", (that is, inflation averse) than the government results in a lower level of inflation offering a solution to the dynamic inconsistency problem (see Rogoff 1985; for recent reviews see amongst others Berger, de Haan and Eijffinger, 2001and Cukierman, 2006aabd 2006b. In general, the econometric evidence suggests that for both developed and developing economies, actual CBI (that is, as actually implemented) is negatively related to inflation (see for example Cukierman, Webb and Neyapti, 1992;Cukierman, 1992;Alesina and Summers, 1993;Berger et al 2001;de Haan and Kooi, 2000;and de Haan et al, 2003).…”

Are public preferences reflected in monetary policy reaction functions?

“…And, indeed, there is an increasing tendency around the world to devolve responsibility for managing monetary policy on an independent central bank. Supporting the wisdom of this trend, the vast majority of empirical literature on the topic finds a negative relationship between central bank independence and inflation (see the literature surveys by Eijffinger and de Haan, 1996;Berger et al, 2001;Hayo and Hefeker, 2002).…”

The Politics of Central Bank Independence

“…In addition, there may be political pressure on the central bank-where the ultimate threat is to remove the central bank's independence-notably if politicians disagree with the central bank's policies (see Ehrmann and Fratzscher, 2011 and references cited therein). 1 This chapter reviews recent research on the political economy of monetary policymaking, both by economists and political scientists, thereby updating our previous surveys on this topic (Eijffinger and de Haan, 1996;Berger et al, 2001 andde Haan, 2010).…”

“…Likewise, if the central bank would be fully under the spell of the government, its inflation aversion would not matter. Only if the central bank is more inflation averse than the government and can decide on monetary policy without political interference, it can credibly promise to keep inflation low (Berger et al, 2001). It is the combination of central bank independence (CBI) and central bank conservatism (CBC) that matters.…”