The Role of Political Institutions for the Effectiveness of Central Bank Independence

Abstract

This paper empirically studies the impact of the quality of political institutions on the link between central bank independence and inflation. Making use of data on the evolution of central bank independence over time and controlling for possible nonlinearities, we employ interaction models to identify the conditions under which more central bank independence will enhance a country's inflation performance. Examining a cross-section of up to 69 countries, we are able to show that granting a central bank more autonomy does not necessarily lead to better inflation performance. To lower inflation by increasing independence, two conditions must be fulfilled: (1) The change in independence must be sufficiently large, and (2) the quality of the political institutions must be sufficiently high.

Central Bank Independence, Inflation, and Poverty in Africa

“…In fact, some studies indicate that price stability is achieved by countries preceding the reformation of their central banks (Siklos, 2008). Hielscher and Markwardt (2012) call for a limit on the degree of independence of central banks based on the discovery of a non-linear relationship between CBI and inflation. The promotion of CBI in Africa is largely propelled by the Economic Community of West African States (ECOWAS), the African Monetary Union (AMU), and the South African Development Community (SADC).…”

What Drives Inflation and How: Evidence from Additive Mixed Models Selected by cAIC

“…Calderón and Schmidt-Hebbel (2010) employ per capita income as a proxy of a more general group of institutional arrangements. Hielscher and Markwardt (2012) employ GDP per capita to control for various structural disparities as differences in the financial sector, technologies or optimal inflation.…”

“…This evidence notwithstanding, the literature has little to say about what conditions support the effect of independence on inflation. As pointed out by Hielscher and Markwardt (2012), while many studies include a range of control variables, there is very little analysis into the interaction between them. Hielscher and Markwardt (2012) show in a cross-section of 69 countries that higher independence does not necessarily improve the inflation performance.…”

“…As pointed out by Hielscher and Markwardt (2012), while many studies include a range of control variables, there is very little analysis into the interaction between them. Hielscher and Markwardt (2012) show in a cross-section of 69 countries that higher independence does not necessarily improve the inflation performance. What is crucial is not only a sufficiently large increase in independence, but also a high quality of political institutions.…”

The political economy of IMF conditionality and central bank independence

“…From a government's perspective, enhancing CBI implies substantial economic and political benefits that often outweigh the costs of losing direct control over a powerful instrument. Besides sending a strong signal to international investors, delivering relief from speculative pressures, CBI 4 A substantial literature already discusses the effectiveness of legal central bank reform in fostering greater de facto CBI (Berger, de Haan and Eijffinger, 2001;Hayo and Hefeker, 2002;Hielscher and Markwardt, 2012;de Haan and Eijffinger, 2019). Although Keefer and Stasavage (2003), Voigt (2008), andHielscher andMarkwardt (2012), argue that the effectiveness of CBI conditionality might be limited in weak institutional environments, recent findings of Garriga and Rodriguez (2019) indicate that granting greater legal independence might help ground inflation, independent of these aforementioned institutional factors.…”