Section 1

research

Central Bank Independence

ECB

ECB by Adam Baker / BY CC

Price stability is a major concern for governments of developed and developing countries alike. Unchecked inflation is among the most dangerous threats to steady, long-term economic growth. Governments that proactively manage inflation rates soften the economic swings resulting from business cycles; this allows both consumers and investors to form more accurate and steady expectations of the future. This stable environment is increasingly valuable for all nations. But it is particularly important for developing states, where evidence of instability can result in the withdrawal of foreign investment funds that are vital to their economic development.

A long recognized threat to price stability is manipulation of the economy by politicians responding to electoral threats or the concerns of key supporters. Price stability is often in direct conflict with politicians' incentives to use monetary policy for objectives such as financing budget deficits, establishing low interest rates or attaining high employment. The use of monetary policy to pursue these other objectives typically achieves short-term benefits and political support, but often at the cost of stable, long-term economic growth. As a consensus has emerged that monetary policy is a more effective way of managing long-term economic growth than fiscal policy, the cost of allowing politicians to use monetary policy as a political tool has increased. In addition, the growth of the currency trading industry, and the speed at which transactions are carried out, make the slow process through which politicians devise economic policy ineffective. Consequently, central banks have emerged as key players in the conduct of monetary policy.

The effectiveness of the central banks as economic policymakers depends in large degree on their independence from the government. A bank that is vulnerable to the whims of politicians will be affected by the same pressures that influence politicians. Thus, the independence of central bank has emerged as an increasing important concern to both policymakers and academics over the past several decades. Despite this, studies of central bank have been deficient, both in the countries included (mostly developed countries) and the time frame covered (most data series stop in the late 1980s). These deficiencies led the Cline Center to initiate the Central Bank Independence project, which was managed by Peter F. Nardulli and given intellectual coherence by William Bernhard and Christopher A. Hartwell, of the World Bank. It was ably implemented by Andrew Oswiak who assembled and coded central bank laws for over 150 countries. While efforts are on-going to augment the archive of central bank laws, a preliminary version of a white paper has been prepared by Hartwell and Nardulli; efforts to construct a satisfactory scale of CBI have not yet been completed.