Time-inconsistency and expansionary business cycle theories: What does matter for the central bank independence–inflation relationship? |
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| Institution: | 1. EDC Paris Business School, OCRE-Lab., Courbevoie, Paris, France;2. University of Sousse, Faculty of Economics and Business of Sousse, MOFID-UR13-ES60;3. Université de Lorraine, BETA Laboratory, CNRS-UMR 7522;1. Montpellier Business School, Montpellier Research in Management, 2300 Avenue des Moulins, 34185 Montpellier Cedex 4, France;2. Department of Business Administration and Law, University of Calabria, 87036 Arcavacata di Rende, CS, Italy;3. School of Accounting, Economics and Finance, University of Wollongong, Wollongong, NSW, Australia;1. Frankfurt School of Finance and Management, Department of Economics, Adickesallee 32-34, 60322 Frankfurt, Germany;2. Department of Actuarial Mathematics and Statistics, Heriot–Watt University, Edinburgh, Scotland, EH14, 4AS, UK;3. Department of Industrial Engineering and Operations Research, Columbia University, New York, NY 10027, USA;1. Department of Finance, Beijing Jiaotong University, Beijing, China;2. School of Economics and Management, Nanchang University, Nanchang, China |
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| Abstract: | Since the seminal paper of Kydland and Prescott (1977), a central bank’s independence (CBI) has been considered an important institutional condition for achieving lower inflation. Recently, however, this long-held belief has been challenged. This paper investigates the relationship between CBI and inflation for a large sample (91 countries) covering the period from 1990 to 2014. We follow the previous literature by considering differences across national monetary regimes in explaining this relationship. Our approach also traces the sources of the inflationary phenomenon. Using panel data and the turnover indicator as a proxy for CBI, we offer two main findings. First, we identify the role of exchange rate regimes in the dynamic between inflation and CBI. Second, our results show that only intermediate and flexible exchange rate regimes are appropriate in this relationship. This finding is explained by the level of CBI, which is very low for countries with a fixed exchange rate policy and low income levels. For policymakers, our results highlight the importance of the choice of monetary regime in controlling inflation in the presence of CBI. For public agents, our results provide guidelines for formulating expectations. |
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| Keywords: | exchange rate regime monetary policy turnover income level panel data |
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