Political institutions and central bank independence revisited

Abstract

We build on earlier studies regarding Central Bank Independence (CBI) by relating it to political, institutional and economic variables. The data suggest that CBI is positively related to the presence of federalism, the features of the electoral system and parties, the correlation between the shocks to the level of economic activity in the countries included in the sample and, for a sub-sample of economies, the convergence criteria to join the European Monetary Union (EMU).

Notes

¹For a survey see Cukierman (1992, 2008).

²Recent works on this topic include D'Amato et al. (2009) and Polillo and Guillén (2005).

³To explain cross-country variation in the observed degree of independence the theoretical commitment approach (Rogoff, 1985; Lohmann, 1992) argues that the costs of an independent central bank, from the government's point of view, consist mainly of the loss of flexibility in monetary policy-making. The balance between flexibility and credibility determines the equilibrium degree of CBI in a country. The balance between costs and benefits in delegating the power to manage paper money may depend on many aspects of the economy and on its institutional framework.

⁴In a checks and balances system the legislative function is equally divided between at least two decision-making bodies (two-chamber parliamentary system or the opportunity for the active voters to request a referendum), which hold veto powers.

⁵Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Holland, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, United Kingdom and United States.

⁶We use the correlation between the GDP growth in each country and a weighted average of the growth rates of the economies in the sample. The weights are the GDP levels in each country. The results do not depend on the proxy for the common component. On this point, see D'Amato et al. (2009), note 11.

⁷See D'Amato et al. (2009) for further details on the variables and their relation with the CBI.

⁸Please refer to the DPI (2006) for a definition of each variable included in the above-mentioned groups. The previous version of this database is described in Beck et al. (2001). The updated DPI (2006) by Keefer (2006) is maintained at the URL: http://go.worldbank.org/2EAGGLRZ40. Note that we use the same variable definitions when we comment on the results.