Political influence,central bank independence and inflation in Africa: A comparative analysis

This paper develops a new de facto measure of central bank independence (CBI) based on two recent measures of the turnover rates of central bank governors introduced by Vuletin and Zhu (2011), complemented with measures of alliance with the government in power, captured by prior executive appointment, tribe proximity, and political party affiliation. Using 1980–2009 data from 13 countries from the CFA zone (a currency union) and 18 non-CFA countries, the new index is used to 1) examine whether CBI can help achieve price stability in Africa and 2) show how CBI affects African countries that are part of a monetary union. We find that higher turnover rates lead to higher inflation. Our results are robust to the decomposition of the turnover rates into premature removals and ally replacements. Furthermore, we find that for CFA zone countries, central bank autonomy has no effect on inflation and instead inflation is driven by other variables such as the fixed exchange rate regime or commodity price shocks.     

Time-inconsistency and expansionary business cycle theories: What does matter for the central bank independence–inflation relationship?

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.     

Does greater central bank independence really lead to lower inflation? Evidence from panel data

It has long been held that central bank independence (CBI) from political control is a necessary requirement to curb inflation. In recent times, however, this long held belief has been challenged. Using a recently compiled panel data set on central bank independence measures, the proposition that greater CBI leads to lower inflation is tested, using latent variable analysis. The use of this alternative econometric technique, along with two additional indicators that capture more appropriately the degree of de facto independence, leads to empirical results that are highly supportive of the negative relationship between CBI and inflation, thereby restoring faith in the conventionally held wisdom, that greater CBI is needed to lower inflation.     

IMF conditionality and central bank independence

This paper studies the role of the International Monetary Fund (IMF) in promoting central bank independence (CBI). While anecdotal evidence suggests that the IMF has been playing a vital role for CBI, the underlying mechanisms of this influence are not well understood. We argue that the IMF has ulterior motives when pressing countries for increased CBI. First, IMF loans are primarily transferred to local monetary authorities. Thus, enhancing CBI aims to insulate central banks from political interference to shield loan disbursements from government abuse. Second, several loan conditionality clauses imply a substantial transfer of political leverage over economic policy making to monetary authorities. As a result, the IMF through pushing for CBI seeks to establish a politically insulated veto player to promote its economic policy reform agenda. We argue that the IMF achieves these aims through targeted lending conditions. We hypothesize that the inclusion of these loan conditions leads to greater CBI. To test our hypothesis, we use a recently available dataset on IMF programs that includes detailed information on CBI reforms and IMF conditionality for up to 124 countries between 1980 and 2012. Our findings indicate that targeted loan conditionality plays a critical role in promoting CBI. These results are robust towards varying modeling assumptions and withstand a battery of robustness checks.     

Qualitative analysis of Bayes–Nash equilibrium in weak asymmetric auctions

It is now generally accepted that there is a negative relationship between inflation and central bank independence (CBI). This study finds that inflation and CBI are endogenously determined, yet the negative correlation between the two remains robust.     

Sectoral variability and the foundations of optimal inflation rate

The recent monetary search models argue that the real effects of inflation on economic activity can be gauged through relative price variability (RPV). Our study uses a large panel data of 32 developed and emerging European economies to test the relationship between inflation and RPV. We use a panel threshold model to explore the regime-specific effects of inflation on RPV. Our results confirm a non-linear profile of the relationship between inflation and RPV. Consistent with the monetary search models, our results show that the effects of inflation on the RPV are more significant in its low (below 0.792% per annum) and high (beyond 2.064% per annum) regimes. Finally, we also report a strong moderating role of central bank independence (CBI) in the inflation–RPV relationship.     

Globalization, the output-inflation tradeoff and inflation

This paper provides comprehensive evidence on the relation between inflation and globalization, defined here as trade and financial openness, using a large cross-section of 91 countries over the period 1985-2004. We establish two main empirical regularities: both higher trade and financial openness (i) reduce central banks’ inflation bias, yielding lower average inflation and (ii) are associated with a larger output-inflation tradeoff. This evidence is at odds with the standard Barro-Gordon framework, which would require globalization to have a negative effect on the output-inflation tradeoff to yield lower equilibrium inflation, but it is consistent with a recent strand of new Keynesian models emphasizing the role of imperfect competition and nominal rigidities. Our findings also support the relevance of the time-inconsistency hypothesis, which underlies the theoretical models predicting a relation between globalization and inflation. For the OECD subsample, however, we do not find an effect of openness on inflation (the output-inflation tradeoff), suggesting that these countries have created an institutional framework for central banks that eliminates distortions due to the time-inconsistency problem.     

Reconsidering central bank independence

In this paper, we survey the case for central bank independence (CBI). We conclude that CBI is neither necessary nor sufficient for monetary stability. CBI is just one potentially useful monetary policy design instrument among several, and CBI should not be treated as an exogenous variable. Instead, the question that should be addressed is why societies decide to make their central banks independent? The reasons why CBI is chosen are related to legal, political, and economic systems. A number of empirical studies find correlations between CBI and low inflation rates. Endogeneity of CBI suggests, however, that the correlation has no implications for causality.     

Fixed exchange rates,independent central banks and price stability in postcommunist countries: Conservatism and credibility

Central bank independence (CBI) and fixed exchange rates are used by governments to achieve stable prices. This article analyzes the mechanisms through which the two monetary institutions could work: Indirectly via a disciplinary effect on money growth rates or via an additional credibility effect on inflation expectations and the cost of capital. I further explain how both discipline and credibility are affected by the distinct flaws of independent central banks and fixed exchange rates: central banks lack transparency and fixed exchange rates take many shapes and are routinely devalued. The argument is tested with quarterly data from postcommunist countries for years 1991 to 2007. The findings show a strong disciplinary effect of monetary institutions on rates of M2 change and an effect on inflation controlling for money growth, but credibility does not extend to lower real short‐term market interest rates. Political institutions do condition the effect of central bank independence, while the types of fixed exchange rates affect money growth rates and inflation to different degrees.     

Central bank independence,fiscal deficits and currency union: Lessons from Africa

Can central bank independence (CBI) help to reduce fiscal balances? In this paper, we answer this question using novel measures of CBI based on the turnover rate of central bank governors (TOR) and the Garriga measure of legal independence for 30 African countries for the period 1990–2017. Our novel measures of CBI capture the degree of alliance between the fiscal authority and the monetary authority which can potentially lead to debt monetization and higher fiscal balances. Thus, we classify central bank governor changes into ally changes or non-ally changes; in addition to that, we decompose our full sample into CFA zone countries and non-CFA zone countries to capture the effect of currency union membership. Our results show that for CFA zone countries, central bank autonomy, when proxied by the turnover rate of central bank governors, is associated with a decrease in fiscal balances and replacing a central banker with a non-ally, is negatively and significantly associated with fiscal balances.     

Central bank independence and ageing

We contrast the influence of demography and Central Bank Independence (CBI) on inflation. The recent demographic trends in developed countries are shown to weight more on inflation than CBI, while the contrary stands for the period from 1960 to 1979.     

Do departures from democratic accountability compromise the stability of public finances? Keynesianism, central banking, and minority governments in the Canadian system of party government, 1867–2009

This paper is concerned with the effectiveness of Westminster parliamentary institutions in ensuring the stability of a nation??s public finances. Our starting point and major hypothesis is that the governance structure embodied in Canada??s parliamentary system has contributed importantly to the maintenance of fiscal stability. The fact that the Government of Canada, like the central government of many other modern democracies, has survived for over a century without default on its public debt means that in some meaningful sense, long run responsibility with respect to the nation??s finances has in fact been achieved, and we show that this is in fact the case. Hence a more meaningful test of our main hypothesis requires the designation of specific sub-periods when the ideological background for political policy making changed and/or when the institutions and organizations for operationalizing policy varied in ways that either improved or discouraged responsible fiscal performance. We consider ideational and institutional factors that are predicted to either enhance or detract from accountability and fiscal stability, including central banking, the adoption of Keynesianism, inflation targeting and periods of minority government, and test for their effects on long run stability of the debt to GDP ratio using data for almost the entire history of the modern state from 1867 to 2008.     

Measuring central bank independence: a latent variables approach

We argue that central bank independence (CBI) is a latent variable of which the various existing quantifications are imperfect indicators. We show how factor analysis techniques can be employed to assess the quality of the various indicators, and how an optimal weighting of the indicators can be obtained that gives the best approximation of CBI. We also show how these results can be utilized in models in which CBI is an explanatory variable. In contrast to the well‐known study of Campillo and Miron (1997) , we find that our CBI indicator is significantly related to inflation, also when various control variables are included.     

More effective than we thought: Central bank independence and inflation in developing countries

This study examines the effect of legal central bank independence on inflation in developing countries. In spite of the policy consensus suggesting that central bank independence is an effective tool to control inflation, the evidence is still limited, particularly for developing countries. Using a novel dataset, we analyze the effect of central bank independence on inflation for a sample of 118 developing countries between 1980 and 2013. We find that higher central bank independence is associated with lower inflation rates. This effect on inflation is stronger the more democratic a country is, but it is also present in non-democratic countries. Our results are robust to different specifications and methodologies. Furthermore, we find that all dimensions included in the measurement of central bank independence (objectives, personnel, policy, and financial independence) contribute to curb inflation. Our results shed light on which types of reforms may be more effective at fighting inflation in developing countries.     

Optimal monetary policy revisited: does considering US real-time data change things?

The primary goal of this article is to investigate whether properly modelling real-time data and optimal real-time decision-making of a monetary planner provides new insights into monetary policy behaviour and outcomes. This article extends a variant of the asymmetric preference model suggested by Ruge-Murcia to investigate the use of real-time data available to policymakers when making their decisions and revised data which more accurately measure economic performance, but is only available much later. In our extended model, the central banker targets a weighted average of revised and real-time inflation together with a weighted average of revised and real-time output. Moreover, we allow for an asymmetric central bank response to real-time data depending on whether the unemployment rate is high or low. Our model identifies several new potential sources of inflation bias due to data revisions. Our empirical results suggest that the Federal Reserve Bank focuses on targeting revised inflation during low unemployment periods, but it weighs heavily real-time inflation during high unemployment periods. The inflation bias due to data revisions is comparable in magnitude to the bias from asymmetric central banker preferences with the bias being somewhat larger during high unemployment.     

The political economy of IMF conditionality and central bank independence

International organizations (IOs) often drive policy change in member countries. Given IOs' limited political leverage over a member country, previous research argues that IOs rely on a combination of hard pressures (i.e., conditionality) and soft pressures (i.e., socialization) to attain their political goals. Expanding this literature, we hypothesize that IOs can enhance their political leverage through loan conditions aimed at enhancing the political independence of key administrative units. Studying this mechanism in the context of the International Monetary Fund (IMF), we argue that through prescribing structural loan conditions on central banks (CBI conditionality), the IMF empowers central banks to gain more political leverage with the aim to limit a government's ability to (ab)use monetary policy for political gain. Divorcing monetary authorities from their respective government, the IMF intends to alter political dynamics towards achieving greater program compliance and enhance long-term macro-financial stability. Relying on a dataset including up to 124 countries between 1980 and 2012, we find that the IMF deploys CBI conditionality to countries with fewer checks and balances, a less independent central bank, and where the government relies more heavily on the monetization of public debt.     

Government consumption,government debt and economic growth

This paper compares the effects of government consumption and government debt on economic growth using data from 83 countries, including both developed and developing markets, over the period from 1960 to 2014. Linear regressions reveal that the negative effects of government consumption are relatively higher than the negative effects of government debt. A nonlinear investigation further suggests that the restrictions on government expenditure to prevent negative growth are more important for countries with lower trade openness, lower inflation, or greater financial depth, whereas the restrictions on government debt are shown to be more important for countries with higher trade openness, lower inflation or greater financial depth.     

Monetary institutions, budget deficits and inflation : Empirical results for eight countries

This study examines the implications of central bank independence using a three-equation model of monetary base growth, budget deficits and inflation that is estimated over an eight-country sample — of which Switzerland, the United States and West Germany are the countries considered to possess relatively autonomous central banks. A main finding is that central bank policy appears to be directed more toward price stability and less toward accommodation of government budget deficits in countries with a central bank that is independent of government. There is also some suggestion that the inflationary consequences of monetary expansion may be lessened under a more decentralised institutional setting.     

Openness, income-tax progressivity, and inflation

This paper considers a model of an open economy in which the degree of income-tax progressivity influences the interaction among openness, central bank independence, and the inflation rate. Our model suggests that an increase in the progressivity of the tax system induces a smaller response in real output to a change in the price level. This implies that increased income-tax progressivity reduces the equilibrium inflation rate and that the effect of increased income-tax progressivity on inflation is smaller when the central bank places a higher weight on inflation or when there is greater openness. Examination of cross-country inflation data provides empirical support for these key predictions.     

Fiscal leadership and central bank design

Abstract.  This article investigates the impact, on economic performance, of the timing of moves in a policy game between the government and the central bank for a government that has both redistributional and stabilization objectives. It is shown that both inflation and income inequality are reduced without sacrificing output growth if the government assumes a leadership role compared with a regime in which monetary and fiscal policy are determined simultaneously. Further, it is shown that government leadership benefits both the fiscal and monetary authorities through the enhanced coordination that this arrangement implies.