Central Bank Independence: Reassessing the Measurements

Article excerpt

The hypothesis that central hank independence improves macroeconomic performance is an alluring one. It is, in the first place, readily grounded in theory: elected governments, periodically needing to face their electorates, have an incentive to overinflate, but independent monetary authorities - having other, more public-spirited objectives - can protect them from temptation. It also offers not only a description of economic ills, but a remedy too: legislate to make central banks more independent. So the science of economics advances: first it explains, then it controls.(1)

Beside the theoretical allure, however, lies an empirical difficulty. If we are to test the independence hypothesis, we must first construct a measure of independence, and it is not a priori clear how to do this. The approach followed most often is to seek to measure relative degrees of independence by comparing the statutes of central banks.(2) However, even this narrowing of attention to statutory characteristics leaves a number of awkward judgments to be made as to which characteristics of the statutes are relevant and how they are to be weighted or combined.

The existence of a difficulty is widely accepted in the literature. For example, A. Alesina [1988, 40] begins by acknowledging that quantifying the elements that determine independence is difficult. He points to the large literature debating the extent to which the Federal Reserve is really independent of the president and Congress and describes the approach of M. Parkin and R. Bade [1985], which he largely follows, as "courageous." In the same spirit, having listed their criteria of independence, V. Grilli, D. Masciandaro, and G. Tabellini [1991, 367] concede that "combining them is unavoidably arbitrary so we adopt the simplest procedure of adding them up." Similarly, A. Cukierman, S. Webb, and B. Neyapti [1992, 383] state that "unavoidably, there were subjective or arbitrary decisions in coding, classifying, and weighing legal information."(3) A. Alesina and L. Summers [1993, 3] in fact go further, asserting that "the central difficulty in examining the question of central-bank independence is measuring the independence of the central-bank in different countries."

Notwithstanding these difficulties, it is striking that the literature appears to have reached a consensus that independence does improve performance. Alesina [1988, 41-42] concludes that

broadly speaking, there is an inverse relationship between the degree of independence of Central-banks and the average inflation rate. The two countries with the most independent Central-hanks had the lowest inflation. The most dependent Central-banks (group 1) had some of the highest inflation rates.

Grilli, Masciandaro, and Tabellini [1991, 375] similarly assert that "central-bank independence is on average associated with lower inflation," and Cukierman, Webb, and Neyapti [1992, 355-6] said that "examining the relation of inflation to alternate indicators for independence reveals that legal [= statutory] independence is an important determinant of inflation in the industrial countries."

And, unsurprisingly, this agreement is commented on by several authors. Grilli, Masciandaro, and Tabellini [1991, 373] wrote: Our results also confirm previous findings obtained by other authors for a different sample of countries and a slightly different ranking of independence" [see Parkin and Bade 1982; Alesina 1989].

Alesina and Summers [1993, 4] are at pains to emphasize the similarity of results: "In our empirical work which follows, we use the average of the two indices . . . Very similar results are obtained when either scale is used individually."

Perhaps more importantly, other scholars draw on this literature in making policy proposals and are frequently impressed by the uniformity of results. A typical example is A. Busch [1994, 58-9], who said, "Several students have tested the hypothesis of an inverse relationship between the degree of central-bank independence and the rate of inflation and found empirical support for it. …