Central Bank Independence in Transition Economies

Wojciech Maliszewski

No 120, CASE Network Studies and Analyses from CASE-Center for Social and Economic Research

Abstract: This paper discusses the role of institutional arrangements in anti-inflationary policy in transition economies of Central Europe and former USSR. The economic theory explains various motives for excessive monetary expansion. Policymakers can be tempted to increase employment above the natural level, collect the seignorage revenue, improve the balance of payment position or stabilise the financial system. The first motive is not very important in the high inflation environment which is characteristic for transition period. Other motives have significant effect on the inflationary history in post communist countries. Revenue motive seems to be crucial for understanding the excessive monetary expansion. The theory predicts that the temptation to use monetary policy combined with rational expectations of the private agents results in inflationary bias in the economy. People know the policymakers' goals and adjust to it by higher inflationary expectations. The optimal policymakers' response is to inflate at the rate expected by the people. The resulting equilibrium is sub-optimal, i.e., the inflation is higher and there are no real gains for the society. The solution to the problem is delegating monetary policy to the independent and conservative Central Banker. The paper investigates the degree of Central Bank's independence (CBI) in transition countries by constructing two indices of legal independence. The results show that the countries more advanced in reforms seem to have more independent Banks. In further analysis a strong relationship between inflation performance and the legal CBI emerges. However, the outcomes of the statistical procedures have to taken with caution. Firstly, the sample under investigation is small and the time horizon is too short to draw any decisive conclusions. Secondly, the transitional economies are at different stages of reforms and the differences in inflation performance may be affected by other factors. Thirdly, the results do not imply causality between CBI and inflation. The independence might be upgraded after the successive stabilisation. The possible extension of the quantitative analysis may be investigation of the duration of the disinflationary process. This is left for further research.

Keywords: Transition Economies; Central Banks; Monetary systems (search for similar items in EconPapers)
Pages: 54 Pages
Date: 1997
References: View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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