Central bank independence: Rules, practices, and outcomes

Douglas Block, University of Texas at El Paso

Abstract

In recent years interest has grown in central bank independence as research has shown that it may affect many important financial issues such as unemployment, inflation, and inflation variability, among others. However, empirical evidence regarding its effect has been inconclusive and there is low correlation among various legal central bank independence measures. In this thesis, I attempt to resolve these problems by generating a new measure of legal central bank independence that takes into account divergence between laws and practices. I then measure the impact that democracy and proportional electoral systems have on reducing this divergence and find that democracy appears to have no impact on divergence, or actually increases it. While the results are mixed for proportional electoral systems, it appears that there will be less divergence between de jure and de facto central bank independence in countries using proportional electoral systems than countries utilizing majoritarian electoral systems.^ Using this information, I then test the impact that the new measure of legal central bank independence has on two key economic variables: inflation and inflation variability. I find that while it is a significant factor for explaining inflation in both developed and developing countries, it has less value in explaining inflation variability. I conclude, therefore, that while this new measure of legal independence provides a better indicator of a central bank’s ability to pursue orthodox monetary policies over the long term, it is not foolproof. Consequently, in the future, model adjustments need to be made to better analyze the impact that the new model of legal central bank independence has on price stability. This will provide long-term stability regarding a country’s economic policies for investors and individuals alike.^

Subject Area

Economics, General|Latin American Studies|Political Science, General

Recommended Citation

Block, Douglas, "Central bank independence: Rules, practices, and outcomes" (2010). ETD Collection for University of Texas, El Paso. AAI1477772.
http://digitalcommons.utep.edu/dissertations/AAI1477772

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