Do Central Banking Institutions Matter?

DoCBInstitutionsMatter.pdf, section 8.5 of Monetary Theory and Policy, 2 ed., MIT Press, 2003.This material was eliminated from the third edition of Monetary Theory and Policy. See References2e.pdf for the bibliographic information on the literature cited in this document. Both the academic literature on discretionary policy and the policy discussions surrounding the design of new policy-making institutions for the European Union and the emerging nations of Eastern Europe have generated increased interest in the role institutional structures play in a¤ecting both policy and macroeconomic outcomes. While Olson (1996) argues strongly that policies and institutions are critical in accounting for cross-country di¤erences in real economic growth, the focus in the monetary literature has been predominantly on the implications of alternative institutional structures for the conduct of monetary policy and for in‡ation. By far the greatest attention has been focused on the relationship between the political independence of central banks and the resulting average in‡ation rates in di¤erent countries. If political pressures lie behind the bias toward economic expansion that the Barro-Gordon model shows leads to an in‡ationary bias, then central banks that are less subject to political in‡uences should be able to deliver consistently lower in‡ation. This proposition has been intensively investigated. Beginning with Bade and Parkin (1984), various authors have constructed measures of central bank independence and have examined the relationship across countries between independence and average in‡ation or measures of real economic performance.2 Much of this literature is surveyed by Cukierman (1992) and Eij¢ nger and de Haan (1996). The general conclusion is that central bank independence among the industrial economies is negatively correlated with average in‡ation; greater independence is associated with lower average in‡ation. Using a measure of independence that was constructed by Cukierman, Webb, and Neyapti (1992) based on the legal charters of central banks and which they call LVAU, …gure 1 shows the relationship between independence and average in‡ation during 1973–1979 and 1980–1993 for a sample of 20 OECD countries.3 This same 2See Alesina (1988), Grill, Masciandaro, and Tabellini (1991), and Eij¢ nger and Schaling (1993). 3The countries included in the sample are Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Luxembourg, Norway, the Netherlands, New