Central Bank Independence and Economic Performance: What Does the Evidence Show?

Prepared for Members and Committees of Congress

Keeping an economy growing over the long run at rates sufficient to provide full employment for
labor and capital with low inflation or a stable price level has been an important goal for
economic policy. Money and monetary policy have figured importantly in achieving this goal.
Currently, it is argued, central bank independence is important to achieving this end.
Many small factors contribute to central bank independence, and so the literature does not yield a
consistent definition of it. Rather, the emphasis is on three aspects of independence, the degree to
(1) the governing board of the central bank is isolated from the political process;
(2) central banks can refuse to finance government budget deficits; and
(3) price stability has primacy as the ultimate goal of central bank activity.
Various indices of central bank independence have been compiled and used in empirical work to
see how closely independence is related to such important performance characteristics of an
economy as the rate of inflation, the growth of output, investment, and real interest rates.
For industrial countries, central bank independence indices embodying definitions (2) and (3)
appear to be closely related to low inflation and low variability of inflation without having any
effect on output and its variability, investment, and real interest rates. In particular, factor (2)
seems to be driving the results, and the various measures of factor (1) have a negligible effect, a
finding that the authors tend to neglect. Since the Federal Reserve cannot directly finance the U.S.
government, factor (2) is not an issue for Congress. However, the results obtained with an index
embodying (3) are of relevance to the conduct of monetary policy in the United States. These
results may be used to support efforts to redefine the objective of monetary policy to focus it
exclusively on price stability.
Critics of these studies point to three major methodological problems and one empirical problem.
First, causation may be opposite to that posited. The desire for economic stability, for example,
may lead to independent central banks. Thus, causation should run the other way around (or it
may run in both directions). Second, central bank independence may arise because an important
and influential constituency in a democratic society favors low inflation. Thus, the ultimate
reason why inflation is low in some countries is the strength of important constituencies who
favor low inflation. And these studies fail to measure this pressure. In a sense, they have captured
only the proximate reason for low inflation, not the ultimate reason. Third, questions have been
raised about the way that the authors transform non-numeric characteristics of independence into
quantitative results. Finally, the data on which some of these empirical estimates are based are
tainted in the sense that the samples commingle observations from the fixed and flexible
exchange rate periods. The performance of central banks is quite different in each regime
regardless of how its stated objective reads. This report will be updated periodically.

Introduc tion ..................................................................................................................................... 1
The Inflation Prone 1970s.........................................................................................................2
The Methodology of the Studies.....................................................................................................3
A Measurable Definition of Central Bank Independence.........................................................4
Bade and Parkin (1985).............................................................................................................4
Grilli, Masciandaro, and Tabellini (1991).................................................................................5
Cukierman; Cukierman, Webb, and Neyapti (1992).................................................................6
Debelle and Fischer (1994).......................................................................................................7
What Does the Evidence Show?......................................................................................................9
Bade and Parkin (1985).............................................................................................................9
Grilli, Masciandaro, and Tabellini (1991).................................................................................9
Alesina and Summers (1993)...................................................................................................11
Cukierman, Webb, and Neyapti (1992); Cukierman, Kalaitzidakis, Summers, and
Webb (1993).........................................................................................................................12
Debelle and Fischer (1995).....................................................................................................14
Froyen and Waud (1995).........................................................................................................14
Fuhrer (1997)..........................................................................................................................15
Campillo and Miron (1997)....................................................................................................16
Posen (1998)............................................................................................................................16
Literature Surveys by Eijffinger and de Haan (1996); Berger, de Haan, and Eijffinger
(2001) ......................................................................................................................... .......... 18
Summary of Empirical Findings.............................................................................................18
General Methodological Criticisms of the Empirical Work..........................................................19
Direction of Causation............................................................................................................19
Definition of Independence.....................................................................................................20
Econometric Shortcomings.....................................................................................................21
Data Problems.........................................................................................................................22
The Relevance of the Empirical Evidence to the Congressional Oversight of Monetary
Policy .......................................................................................................................................... 22
Table 1. Average Annual Inflation Rate in the Industrial Countries, 1950-2006.............................2
Table 2. Measured Independence of Key Central Banks: A Comparison of Studies.......................8
Appendix. A Primer on Some Elementary Principles of Regression Analysis..............................24
Author Contact Information..........................................................................................................25

Keeping an economy growing at a rate compatible with the full utilization of resources over the
long run in an environment in which price inflation is stable has been an age-old goal for
macroeconomic policy. Monetary policy and the institutional arrangements for carrying it out
have long been regarded as important to achieving this goal. Such has been the importance
accorded money in this respect, that numerous monetary arrangements and policies have been
proposed which, if adopted, their proponents argue, would make such a goal attainable. These
arrangements include the gold standard, the real bills doctrine, a compensated dollar, 100%
reserve requirement banking, a fixed growth rate rule for the money supply, a bimetallic standard,
a currency board, free floating exchange rates and inflation targeting, to name but a few in what 1
Professor Stanley Fischer has called “the unending search for monetary salvation.” The current
policy prescription in fashion among economists that promises to promote such a goal is termed
central bank independence (hereafter CBI) which, although it has several possible definitions, has
come increasingly to focus on institutional arrangements, as well as the central bank’s “mandate 2
and ability to focus single mindedly on the attainment of price stability.”
The high inflation in the western world in general during the 1970s, and the difference in the
inflation experience of individual industrial countries which were, on the whole, subjected to
similar external economic shocks, motivated some economists to investigate the possible linkage
between the rate of inflation and the institutional and political arrangements governing the
establishment and functioning of central banks. A major conclusion of these studies is that CBI is
an important part of the explanation for why some countries have had much lower inflation rates
on average than others. The more “independent” the central bank, these studies conclude, the
lower tend to be the average rate of inflation and volatility of inflation experienced by that
country. The reason for these results is that independence supposedly enhances the credibility of
the central bank and increased credibility gives rise to reinforcing behavior via the expectations of
economic agents, be they consumers, suppliers of labor and capital, or firms supplying output.
Thus, shifts in central bank policy are transmitted more rapidly into changes in wages, interest
rates, and prices and, thus, output and employment, than would be the case in the absence of
strong credibility. A minority of the studies even claims that the better governance, lower
inflation, and greater macroeconomic stability provided by CBI have a positive effect on 3
economic growth.
Some newer studies question the methodology underlying these results, and claim that the
relationship between inflation and CBI is weaker than the early studies found. The evidence is
mixed on whether central bank independence has a cost in terms of lower output growth or
greater output variability.
These empirical studies have not gone unnoticed by policy makers. In some ways, the Federal
Reserve is more independent than many of its peers. In other ways, it is less. For example, some
studies have defined a price stability goal as enhancing independence, and there has been periodic

1 See Stanley Fischer, “The Unending Search for Monetary Salvation,NBER Macroeconomic Annual, edited by B.
Bernanke and J. Rotemberg, 1995, pp. 275-286.
2 Alex Cukierman, “The Economics of Central Banking, in Wolf Holger (ed.), IEA, Contemporary Economic Issues -
Macroeconomics and Finance, vol. 5 (The MacMillan Press, 1998), pp. 37-82.
3 For a more complete discussion of the theory behind central bank independence, see CRS Report RL31056,
Economics of Federal Reserve Independence, by Marc Labonte.

congressional interest in giving the Fed such a goal4. If CBI proponents are correct, the Fed’s 5
independence could be enhanced at little cost and much benefit to the U.S. economy.
As Table 1 shows, the decade of the 1970s stands out in the post-World War II era as one of
especially high inflation, although the inflation experience of individual countries is by no means
similar even though they were as a group subjected to a similar range of external economic
shocks, especially the two major increases in world oil prices.
The differences in average inflation rates among these nations motivated a number of economists
to investigate the possible role played by the institutional and political arrangements governing
the establishment and functioning of central banks, since increases in the supply of money are an 6
essential element in explaining inflation.
Table 1. Average Annual Inflation Rate in the Industrial Countries, 1950-2006
(data in percentages)
1950-1959 1960-1969 1970-1979 1980-1989 1990-1999 2000-2006
United States 1.8 2.3 7.1 5.6 3.0 2.8
United 3.5 3.6 12.6 7.4 3.7 1.5
Austria 6.8 3.3 6.1 4.0 2.4 1.9
Belgium 1.9 2.7 7.1 5.1 2.2 2.1
Denmark 3.8 5.3 9.3 7.1 2.1 2.1
France 6.2 3.8 8.9 7.8 1.9 2.0
Germany 1.1 2.4 4.9 2.9 2.3 1.7
Italy 2.9 3.4 12.5 11.8 4.1 2.5
Netherlands 3.8 4.2 7.1 3.1 2.5 2.6
Switzerland 1.1 3.1 5.0 3.3 2.4 1.0
Canada 2.4 2.5 7.4 6.7 2.2 2.3
Japan 3.1 5.4 9.1 2.5 1.2 -0.4
Greece 6.5 2.0 12.3 20.1 11.1 3.4
Ireland 3.9 4.0 12.7 9.9 2.3 3.6
Portugal 0.7 4.0 17.1 18.2 6.0 3.1
Spain 6.2 5.8 14.1 10.6 4.2 3.3

4 See CRS Report 98-16, Should the Federal Reserve Adopt an Inflation Target?, by Marc Labonte and Gail E.
Makinen; and CRS Report RL31702, Price Stability (Inflation Targeting) as the Sole Goal of Monetary Policy: The
International Experience, by Marc Labonte and Gail E. Makinen.
5 With its focus on the relevance of the research to domestic monetary policy, this report will not review the empirical
evidence on the effects of central bank independence in the developing world.
6 Most of the studies reviewed in this report were carried out before the founding of the European Central Bank in
1999, which greatly reduced the number of advanced countries with an independent monetary policy.

1950-1959 1960-1969 1970-1979 1980-1989 1990-1999 2000-2006
Australia 6.5 2.5 9.8 7.6 2.5 3.3
New Zealand 5.0 3.2 11.4 12.5 2.0 2.7
Mean 3.7 3.5 9.7 8.1 3.2 2.2
Standard 1.99 1.08 3.28 5.04 2.17 0.96
Source: For 1950-1989: Consumer prices compiled by the International Monetary Fund and reported in Grilli,
Masciandaro, and Tabellini. Political and Monetary Institutions and Public Financial Policies in the Industrial
Countries. Economic Policy. October 1991, p. 344. For 1990-2006: Consumer Prices compiled by International
Monetary Fund. Statistical computations made by CRS.
If central banks (hereafter CBs) played an important role in the differences in national inflation
rates, they did so for one of two reasons, according to the theoretical literature that was developed
at the time. An inflationary bias on the part of CBs was attributed either to a requirement that they
provide government with revenue (via the inflation tax) or to a desire on the part of the
government to reduce unemployment through a monetary surprise or unanticipated shock. Since
the United States government derives very little revenue from the inflation tax, any inflation bias
on the part of the Federal Reserve must be attributed to a desire by the government to reduce
It is widely believed that a short run tradeoff exists between inflation and unemployment, known
as the Phillips curve. The ability of monetary policy to reduce unemployment in the short run is a
well known fact amply demonstrated in the United States and elsewhere. It is generally attributed
by economists to the shift in policy being a surprise or unexpected event, since anticipated
monetary changes would have been incorporated into wage and price expectations. Since it is also
widely believed by economists that the employment effects of such monetary surprises are only 7
temporary, their longer run consequence is a higher inflation rate. Hence, central banks that try to
exploit the tradeoff described by the Phillips curve, for whatever reason, will impart an 8
inflationary bias to their national economies. From an economic point of view, cycles produced
by monetary surprises are suboptimal and this serves to underpin policy designed to create and
fortify bank central independence devoted to stability. CBI proponents believe that independent
central banks were less likely to attempt to exploit the Phillips curve tradeoff, and would provide
their economies with lower inflation rates as a result.

The basic methodology of the academic studies involves the use of linear regression which is a
statistical technique that attempts to estimate mathematically how important central bank
independence and various parameters of that independence are to such important indicators of

7 This suggests that the longer run Phillips curve is vertical—that no permanent tradeoff exists between unemployment
and the rate of inflation.
8 It is believed by some that such a bias exists in the United States. A theory of political business cycles has come into
existence and claims that the U.S. government has influenced Federal Reserve policy such that prosperous economic
conditions are engineered to coincide with presidential elections in order to favor incumbents. For a discussion of the
political business cycle literature, see Thomas Willet, ed., Political Business Cycles, Duke University Press, 1988.

economic performance as the rate of inflation, the variability of inflation, the growth rate of 9
output, the variability of the growth rate of output, and real interest rates.
To make such computations, the above definitions of central bank independence must be turned
into something that can be measured.
The major studies that have attempted to measure CBI, with an objective of constructing a
ranking of CBs by the degree of their measured independence, begin by looking at the legal
provisions of their charters. They do so because the charter is supposed to set forth what its
framers intended. Thus, the charter usually specifies the policy objective or objectives of the CB,
the procedure for the appointment of the governor or governing body of the CB, the period of
tenure of these officials, the conditions under which they can be removed, the procedures for
resolving conflicts between CB officials and political authorities, and the monetary instruments
under the control of the CB.
Bade and Parkin (hereafter BP) is the first study to construct a CBI index.10 They defined what
they call the financial and policy characteristics of CB charters. As shown below, the less
influence the government has on the CB, the higher is the rank given that CB. The scale for each
of the two sets of characteristics runs from 1 to 4. They use a sample of 12 countries in their 11
The four financial characteristics are the following:

1. Government approves the budget of the CB, determines the board members’ salaries,

and the allocation of its profits;
2. The CB determines its own budget allocations, but the government determines the
board members’ salaries and the allocation of its profits;
3. The CB determines its budget and board members’ salaries while the allocation of its
profits are determined by statute; or

4. The CB determines its budget, board members’ salaries, and profit allocation.

9 A more complete, but elementary explanation of “linear regression” is given in the Appendix. There, one will also
find an elementary explanation ofstatistical significance and “goodness of fit or R2.” An appreciation of all three will
aid in understanding what these studies accomplish.
10 See Robin Bade and Michael Parkin, Central Bank Laws and Monetary Policy, mimeo, University of Western
Ontario, 1985. This study remains unpublished. The index contained in the discussion above is taken from Michael
Parkin,Domestic Monetary Institutions and Deficits,” in Deficits, edited by Buchanan, Rowley, and Tollison, Basil
Blackwell, (London: 1986), p. 310-331.
11 In terms of Table 1, BP exclude from consideration the CBs in Austria, Denmark, Greece, Ireland, Portugal, Spain,
and New Zealand. They include Sweden in their sample, a country that is not included in Table 1.

The four policy characteristics are the following:
1. The government is the final policy authority, has officials on the CB board, and
appoints all board members;

2. Like (1) but with no government officials on the CB board;

3. The CB is the final policy authority, but all appointments to the CB board are made by
the government; or
4. Same as (3) except some appointments to the board are made independently of the
The German and Swiss CBs are the most independent CBs in their sample. They give each a 4
rating for the financial and policy characteristics of their charters. They give the U.S. Federal
Reserve a financial rating of 2 and a policy rating of 3.
Grilli, Masciandaro, and Tabellini (hereafter GMT) construct two CBI indexes, which distinguish 12
between the political and economic independence of CBs. They define political independence to
mean the ability of the CB to define its policy objectives free from government influence. Any
institutional or legal feature or custom that enhances this ability increases the political
independence of the CB. Economic independence is defined to mean that the CB has the freedom
to choose the instruments with which to pursue its final goal or goals.
Their index of political independence gives equal weight to eight factors. The maximum score a
central bank can obtain is eight, which requires a “yes” answer to each question. Such a score
suggests a highly independent CB, according to GMT. The eight questions are

1. Is the CEO of the CB appointed by a body other than the government?

2. Is the CEO’s term more than five years?

3. Are the other governing board members appointed by a body other than the

4. Are their terms for more than five years?

5. Is there an absence of mandatory provisions for government representatives to serve on
the governing board?
6. Is there an absence of a requirement that the government must approve monetary

7. Is there a provision that the CB pursues a goal of price stability?

12 Vittorio Grilli, Donato Masciandaro, and Guido Tabellini, “Political and Monetary Institutions and Public Financial
Policies in the Industrial Countries,” Economic Policy, October 1991, p. 342.

8. Are there charter provisions that strengthen the CB’s position in conflicts with the
They give the U.S. Federal Reserve a score of 5 out of a possible 8 (the reason being that “no”
answers are given to the first three questions). Both the German and Dutch CBs get a rating of 6,
the highest, while the Swiss CB gets a 5.
Seven factors, each also given an equal weight, are used to measure the degree of economic
independence and they are heavily dependent on the degree to which the CB is obliged to finance
government budgets. Briefly, five of the seven factors are the degree to which direct credit to the
government is not automatic, given at market interest rates, for temporary periods of time, and in
limited amounts; whether the CB does not participate in the primary market for public debt, and
whether the CB can set its own discount rate. The other two factors are related to the regulatory
obligations of the CB. According to this index, the Federal Reserve obtains a score of 7 (as do the
CBs of Switzerland, Germany, and Canada).
A more complex set of indexes has been developed in several papers by Cukierman; Cukierman, 13
Webb, and Neyapti (hereafter CWN); and Cukierman and Webb. The first index these authors
compile consists of 16 legal characteristics taken from CB charters and involves both political
and economic factors. These sixteen characteristics are, in turn, grouped into four clusters related
to the appointment, dismissal and legal term of the CB’s CEO; the institutional location of the
final authority for monetary policy and procedures for resolving conflicts between the CB and
government; the degree to which price stability is the primary objective of policy; and the limits
that restrict government from borrowing from the CB. The individual components are not equally
weighted and each country’s CB receives an overall rating in the index that falls between 0 and 1.
It is possible to separate this complex index into various subindexes that correspond closely to the
distinction made by GMT between political and economic independence, a separation that is, in
fact, made by CWN for computation purposes.
The United States ranks as the fifth most independent bank on their index, out of 21 advanced
economies. The Germans and Swiss are most independent in their index as well. Areas in which
the United States is ranked as lacking independence include the relatively short term of the
chairman, the executive branch’s ability to unconditionally dismiss the Fed’s chairman, the
multiple goals of Fed policy, the Fed’s lack of influence over the government budget process, and
the Fed’s ability to buy government securities on the primary market. It is useful to note that
while several of these factors are legally allowed, they are unlikely to ever occur in practice. This
is a drawback of indices based on the legal code—statute may not correspond with practice.
The legal nature of the charter may not be the ultimate measure of CBI. In the words of Prof.
Cukierman: “The basic objective difficulty in characterizing and measuring CB independence is
that it is determined by a multitude of legal, institutional, cultural, and personal factors, many of

13 See Alex Cukierman, Central Bank Strategy, Credibility, and Independence: Theory and Evidence, The MIT Press,
1992. Alex Cukierman, Steven B. Webb and Bilin Neyapti, “Measuring the Independence of Central Banks and Its
Effect on Policy Outcomes,” The World Bank Economic Review, vol. 6, no. 3, 1992, pp. 353-398, and Alex Cukierman
and Steven Webb,Political Influence on the Central Bank: International Evidence,The World Bank Economic
Review, vol. 9, no. 3, 1995, pp. 397-423.

which are difficult to quantify and some of which are unobservable to the general public.” Hence,
CWN compile a second index based on a survey of the opinion of monetary experts in CBs about 14
the true nature of the independence of their institutions.
As a third CBI index, CWN use the turnover rate of CB CEOs, and Cukierman and Webb use
such an index in a political context relating turnover to major political changes. This index is
thought to be more illustrative in the developing world, since frequent turnover in the advanced
economies is rare.
Debelle and Fischer (DF) disagree semantically with the CBI literature, and devise their own 15
variation on the GMT index. Recall that one aspect of GMT’s definition of political
independence is the presence of a price stability goal. DF argue that defining a price stability goal
as enhancing independence is inconsistent. By imposing a strict and measurable goal on the
central bank, the government restricts the CB’s latitude to shape monetary policy as it sees fit. Put
another way, if the CB decided that temporarily directing monetary policy at growth rather than
inflation was in the nation’s interest, under a price stability goal, it would not be “independent” to
pursue that goal. The rest of the literature (with the exception of DF) argues that a price stability
goal enhances independence by giving the CBs an institutional buffer against political
interference in pursuit of “monetary surprises.” Nevertheless, the definition of a price stability
goal as an aspect of political independence is well-established and consistently used in the CBI
literature and will be adhered to in this report.
Because of their disagreement with GMT, DF create their own CBI index consisting of three
parts. They use a political independence index based on the GMT definition of political
independence excluding the price stability goal. The price stability goal is placed in its own index
called goal independence. In contrast to the rest of the literature, they define a CB as having goal
independence if there is no price stability goal, and lacking goal independence if price stability is
the sole goal of monetary policy. They make no effort to measure other factors that could deprive
a CB of goal independence, such as a fixed exchange rate regime, although they acknowledge
that such factors would have that effect.
The third part of the DB index is referred to as instrument independence. They describe
instrument independence as meaning that the CB can achieve its ultimate goal or goals in any
way it chooses, whether the government or the CB has assigned those goals. Thus, for example, it
could exercise discretion in how rapidly the money supply was permitted to grow or it could fix
interest rates at whatever level it thought was necessary. It would not be obliged to finance the
government (a common constraint on many central banks), follow a fixed rule for increasing the 16
money supply, keep interest rates low, or maintain a fixed exchange rate. They use GMT’s

14 A limitation of this index is that it applies only to the decade of the 1980s, whereas the index computed from their
analysis of the legal charters of the CBs is available on an aggregate and decade by decade basis for the period 1950-
15 See Guy Debelle and Stanley Fischer, “How Independent Should a Central Bank Be?” in J. Fuhrer editor, Goals,
Guidelines, and Constraints Facing Monetary Policymakers, Federal Reserve Bank of Boston Conference Series No.
38, 1994, pp. 195-225.
16 There has been a longstanding debate among economists over whether monetary policy should be conducted on the
basis of discretion or rules. In a broader sense, the desirability of central bank independence must be seen in the context
of this debate.

economic independence index, excluding factors related to the CB regulatory duties, as their
measure of instrument independence. Curiously, this measure of instrument independence relates
to only two of the factors they mention: the CB’s freedom to set interest rates and the absence of a
requirement that the CB finance the government’s budget deficit.
While goal and instrument independence (as well as political and economic independence) are
conceptually distinct, there are circumstances in which if one is mandated the other is mandated
as well. One could not, for example, impose a goal of price stability on a CB while
simultaneously imposing on it a requirement to finance a government budget deficit. It would
also be illogical to impose on a CB the requirement that it keep the money supply growing at a
constant percent per year or to keep the exchange rate constant vis-a-vis other currencies while
requiring it to finance a budget deficit.
Table 2. Measured Independence of Key Central Banks: A Comparison of Studies
Bade and Parkin (most GMT (most Cukierman (most
independent=4) independent=16) independent=1)
United States 3 12 0.48
United Kingdom 2 6 0.27
Austria n/a 9 0.61
Belgium 2 7 0.17
Denmark 2 8 0.50
France 2 7 0.24
Germany 4 13 0.69
Italy 1.5 5 0.25
Netherlands 2 10 0.42
Switzerland 4 12 0.64
Canada 2 11 0.45
Japan 3 6 0.18
Greece n/a 4 0.55
Ireland n/a 7 0.44
Portugal n/a 3 0.41
Spain 1 5 0.23
Australia 1 9 0.36
New Zealand 1 3 0.24
Source: Alesina and Summers (1993), Grili, Masciandaro, and Tabellini (GMT, 1991), Cukierman, Webb, and
Neyapti (1992)
Note: Bade and Parkin ranks as measured by Alesina and Summers (1993). GMT index is sum of political index
and economic index.

The literature on central bank independence is extensive. The discussion below is not
comprehensive, but focuses on a few of the key papers in depth to give a flavor for the literature
as a whole. It concludes with the results of two literature reviews that give an overview of the
literature’s general findings.
BP used both their Financial and Policy indexes, compiled for 12 CBs and covering the period

1955-1983, in their pioneering study of the effect of CBI on inflation.

The major conclusion of this study is stated by Parkin:
In studying the relationship between central bank types and inflation performance it
was discovered that just one of the central bank categories stands out as delivering
significantly different—and lowerinflation than the others. This is a policy type 4central
banks that are independent in the two senses that the central bank is the final monetary
authority and has power to make some of the Board appointments (Germany and
Switzerland). Differences in financial types are in no significant way associated with
differences in inflation performance and variations over the first three policy types are also 17
associated with no significant differences in inflation behavior.”
The study established that Switzerland and Germany, the only two policy type 4 countries, have
an average inflation rate that was less than half as high as the other 10 countries in their sample.
While these results are interesting and served to kindle research in this topic, they should be read
with great care. In establishing their results, BP commingle observations from two different
international exchange rate regimes. The relevance of this factor is discussed in the
Methodological Criticisms section below.
GMT compute the degree of political and economic independence, as defined above, for each of 18
the 18 countries listed in Table 1. The scatter of observations for each measure of independence
becomes the data set for the two independent variables used in their regressions. The dependent
variable is the average inflation rates for these same countries. Individual regressions are
computed on data averaged over the decades of the 1950s, 1960s, 1970s and 1980s and for the
entire period 1950-1989.
They find that their measure of economic independence is inversely related to average inflation
rates in a statistically significant way during the decade of the 1970s and 1980s and over the
entire period 1950-1989. Political independence is inversely related to inflation over all four
periods and the entire period, but it is only statistically significant over the decade 1970-1979.

17 Michael Parkin, “Domestic Monetary Institutions and Deficits,” in Deficits, edited by Buchanan, Rowley, and
Tollison, Basil Blackwell (London: 1986), p. 321.
18 See Vittorio Grilli, Donato Masciandaro, and Guido Tabellini, “Political and Monetary Institutions and Public
Financial Policies in the Industrial Countries,” Economic Policy, October 1991, pp. 342-392.

The authors interpret these results to mean that since the degree of central bank independence is
negatively related to the average rate of inflation in a statistically significant way, “monetary
institutions matter.”
Although this general conclusion may be true, the GMT results must be interpreted carefully.
Those from the entire period, 1950-1989, are of questionable value because, like the Bade and
Parkin results, they are derived from data taken from two quite different international exchange
rate regimes, the Bretton Woods regime of fixed exchange rates and the subsequent era of floating
exchange rates (for a discussion, see the section on methodological criticisms). It is interesting in
this respect that the GMT results show that neither economic nor political independence is
statistically significant in explaining the inflation performance of the 16 countries in their sample
during the decades 1950-1959 and 1960-1969. This is what one might reasonably expect during
the fixed exchange rate era.
Contrary to the conclusion of the authors, the results for 1970-1979 and 1980-1989 suggest that
the inflation performance of these countries is not so much related to the policy goal and methods
of choosing CB governors and their terms of office (their measure of political independence) as it
is to the requirement that the CB not be used to finance the government’s budget deficit, their
measure of economic independence. The political independence variable is not statistically 19
significant for the 1980-1989 period and is only weakly significant for the 1970-1979 period.
Thus, regardless of the CB’s degree of political independence, countries that maintain reasonable
budget balance or have good prospects of financing their budget deficits from private saving, may
remove the pressures from their CBs, making it possible for the CBs to concentrate monetary 20
policy on achieving low inflation.
One aspect of the GMT inflation-CB independence results is of interest. They are able to explain
a high proportion of the difference in the inflation experience of their sample group of countries
with their central bank independence variables. For the decades of the 1970s and 1980s, the R-
squared ranged from .66 to about .75 (and for the period 1950-1989, nearly .8).
The reason this result is interesting is that increases in the supply of money are widely
acknowledged to be the proximate cause of inflation since a continuous rise in the price level, the
essence of inflation, is generally only possible with a continuous rise in money growth relative to
the growth of output. If the degree of central bank independence is the ultimate cause of inflation,

19 Being weakly significant means that one is willing to set the risk of accepting as true a false hypothesis at something
above 5 chances in 100.
20 The conclusions of the GMT study are derived from a comparison of data over a number of years on their measures
of central bank independence and various measures of economic performance. This same conclusion on the relationship
of central bank independence and the control of inflation has been derived from considering several episodes of
hyperinflation. Each of the episodic studies cited below concluded that an important reason for the successful
stabilization of the affected economies was a provision in the stabilization law that central banks not be used to finance
governments and the faithful adherence by these governments to that law. See Thomas Sargent, “The End of Four Big
Inflations,” in Inflation Causes and Effects, edited by R. Hall, University of Chicago Press, (Chicago: 1982), pp. 41-97;
William Bomberger and Gail E. Makinen, “The Hungarian Hyperinflation and Stabilization,” Journal of Political
Economy, vol. 91, no. 5, October 1983, pp. 801-824; Gail E. Makinen, “The Greek Stabilization of 1944-46,” American
Economic Review, vol. 74, no. 5, December 1984, pp. 1067-1074; and Gail E. Makinen and Thomas Woodward, “The
Taiwanese Hyperinflation and Stabilization of 1945-1952,” Journal of Money, Credit, and Banking, vol. 21, no. 1,
February 1989, pp. 90-105. From the perspective of these earlier episodic studies, the present work on central bank
independence and low inflation has little to offer that is new.

these regressions are able to explain a great deal. The evidence adduced by some other
investigators reported below is not this strong.
A final aspect of their work that has attracted attention is that central bank independence has no
adverse effects on the crucial performance parameters of the economy. The improved inflation
performance that supposedly comes with CB independence does not come at a cost of lower
output growth or greater variation in that growth for both measures of CB independence are
statistically insignificant in explaining both these parameters of performance (see their table 16,
p. 374).
Alesina and Summers (hereafter AS) create an index that is a combination of the BP policy index 21
and the two indexes of GMT. The GMT combined index of political and economic
independence for each CB is converted to the BP range of 1 to 4 and is then averaged with the BP
Policy index for that same central bank to produce the AS index of central bank independence.
The U.S. Federal Reserve rates a 3 on the BP Policy index, a 12 on the combined GMT index, 22
and a 3.5 on the AS index.
Alesina and Summers use a sample of 16 developed countries (virtually the same sample as that
in Table 1) with data spanning the period 1955-1988. They conclude: “... the monetary discipline
associated with central bank independence reduces the level and variability of inflation but does 2324
not have either large benefits or costs in terms of real macroeconomic performance.
These conclusions are drawn from a series of scatter diagrams, one for each measure of economic
performance. The variable common to each scatter diagram is their CBI index. The index they
use, as explained above, is a combination of the BP policy index and the sum of both of the GMT
indexes converted to a BP scale of 1 to 4.
As with the previous study, it is possible to argue that the conclusions drawn by AS are at best
tentative in nature. This is so for several reasons. First, these results are established by looking at
scatter diagrams. There is no attempt to control for other factors that could be driving the results.

21 See Alesina, Alberto and Summers, Lawrence H. Central Bank Independence and Macroeconomic Performance:
Some Comparative Evidence. Journal of Money, Credit, and Banking, vol. 25, no. 2, May 1993, pp. 151-162. Some of
the empirical work in this paper is based on the update of the BP index made by Alesina to include additional countries.
See his Macroeconomics and Politics in NBER Macroeconomics Annual for 1988, edited by Stanley Fischer
(Cambridge, MIT Press, 1988), pp. 17-52.
22 These various indexes are highly correlated with each other. Work by Posen shows that the rank correlation
coefficients of the BP, GMT converted to a BP scale, and the AS indexes to the Cukierman index are, respectively, .65,
.62, and .62 (on a scale of -1 to +1). See Adam Posen, Central Bank Independence and Disinflationary Credibility: A
Missing Link,” Federal Reserve Bank of New York Staff Reports, no. 1, May 1995, p. 34.
23 Meaning that CBI has little or no effect on average real GNP growth, the variance of real GNP growth, average per
capita GNP growth, the variance of per capita real GNP growth, average unemployment, the variance of
unemployment, the average real interest rate and the variance of real interest rates. While these findings suggest no
longer run relationship between CBI and these measures of performance, the finding of Posen (1988) (see below) is of
interest: CBI apparently does not lead to an improved disinflation performance.
24 This latter finding is important because it supports a fundamental proposition of economics, the so-called neutrality
of money. This is the view that changes in the growth rate of money can affect real variables such as income growth
and unemployment in the short run, while in the longer run it affects only the rate at which the price level and nominal
wages rise and the level of market interest rates.

No empirical evidence that the posited relationships are statistically significant is presented. Even
if they are significant, there is no evidence presented about the importance of CBI to the measures 25
of economic performance. Second, the data are averaged across exchange rate regimes. As
noted above, the constraints placed on CB behavior by a fixed exchange regime are quite
different from those placed by a flexible rate regime. Third, since AS use the combined GMT
index, and GMTs measure of economic independence dominates that index, their results may be
showing that a constraint placed on CB financing of government is the important factor
explaining the behavior of their measures of economic performance; more so than those elements,
for example, that are designed to isolate the governing boards of CBs from political interference.
It may well be a misstatement to conclude, as they do, that greater CBI is conducive to low
inflation without any deleterious effect on other characteristics of economic performance. A more
qualified statement focusing on constraints placed on CB lending to governments may be more
consistent with their evidence.
This study is based on a very large sample of central banks conveniently grouped by the authors
into those for industrial and those for developing countries. The group of industrial countries is
similar to those listed in Table 1 and used by BP, GMT and AS. The results reported below are
only for the industrial subsample of central banks. The data apply to a combined period running 26
from 1950 to 1989.
The first test uses linear regression to explain the inflation behavior among the industrial
countries in which the major explanatory variables are the disaggregated components of their first 27
or legal CBI index and the turnover rate of CB CEOs, their third index. Fearful that statutory
CBI measured by their index may not be honored in practice, they hypothesize that the turnover 28
rate for the central bank’s CEO may give an indication of CBI in practice. Not a single variable

25 The authors rely on scatter diagramsthey do not compute regressions. For that reason, we do not know if the
relationship between CBI and inflation is statistically significant. That is, we do not know if the variance in the 2
relationship renders it indistinguishable from zero. We also have no R measure. It may be, for example, that their
measure of CBI is statistically significant in explaining the inflation behavior of these countries, but that it only
explains a very small part of that behavior.
26 Although their study covers both the floating and fixed exchange rate regimes, in a sense this factor is controlled for
by including variables to capture differences in each decade.
27 Actually, CWN do not use the inflation rate as the variable whose behavior they try to explain. Rather, they use a
transformed variable that represents the rate of depreciation of money. The reason is that an average inflation rate for a
group of countries can be distorted if one or several countries have very high inflation rates.
28 This approach is further explored in Cukierman and Webb (1995). The approach in this study is to judge political
influence by how closely political transitions of various types are related to the frequency and timing of changes in the
CEOs of central banks. Given various assumptions about the length of time in which this occurs, Cukierman and Webb
compute an index of the nonpolitical turnover of the CEO. In addition, an index of CB political vulnerability is also
computed. The data cover a large number of countries during the period 1950-1989. Unfortunately, they do not run
separate regressions for industrial and developing countries. They do try to control for developing countries by using a
technique to enter them as a separate independent variable.
For the entire group of countries they find that both of the new indexes have a positive effect on the transformed
inflation rate (see above for an explanation) as well as its variability. They also find that the fixed exchange rate period 2
had a negative effect on the inflation rate (which is statistically significant). The overall R for these regressions ranged
from .34 to .41. They also find that their two new measures of CB independence yield mixed results in explaining real
economic growth. The results depend on the index and the size of the sample. Only the vulnerability index affects real

in these two indexes is statistically significantly different from zero (at conventional 1% to 5%
levels of significance).
However, when the measure of legal independence is entered in its aggregated form, it is 29
statistically significant while the index of CEO turnover is not (at conventional levels). This
tells us that for industrial countries, the rate of inflation experienced by the group is negatively
related to CWN’s measure of CBI that is derived from the legal aspect of the bank’s charters. 2
(The Rs for these regressions are in the .25 to .35 range.) As the authors conclude: “Laws do
make a difference.” But what laws do they have in mind? Those that ensure that the banks
governors are independent from political influence or those that circumscribe lending by the CB
to the government or various firms and enterprises? Or both? Actually, it turns out to be those
associated with lending to the government.
CWN take from the legal index those components pertaining to limits on CB lending to the
government or to various firms and enterprises. This subindex is similar to the GTB index of
economic independence. After additional regressions, they conclude that this subindex drives the
result for the industrial countries. “The other components of the legal independence variable—
CEO, policy formation, and objectives—do not make any significant contribution to explaining
inflation (in industrial countries).” In this regard their findings are similar to those of GBT for a
smaller sample of developed countries. Unfortunately, they provide neither the coefficient value 2
of this variable nor the R of the equation. They do tell us that the variable is statistically
significant, however.
As an additional test, CWN explore what relationship exists between inflation variability (or 30
uncertainty) and CBI. For the industrial countries, neither the aggregated legal CB index or the
turnover rate of CB CEOs is statistically significant at conventional 1% to 5% levels of
The basic study by CWN has been extended by Cukierman, Kalaitzidakis, Summers and Webb to
investigate the effect of central bank independence on other performance indicators of the
economy: output growth, investment, and real interest rates. They find that neither the legal
independence index nor the index of CB CEO turnover helps explain the variations in growth
rates over the period 1965-1989 within this group of industrial countries. They do find, however,
that the legal independence index has a significant negative effect on the variability of real
interest rates and, if Ireland is excluded from the sample, a significantly positive effect on the
level of real interest rates. The last result is contrary to expectations. The authors speculate that it

interest rates; the R2, however, is only 0.05. See Alex Cukierman and Steven B. Webb, “Political Influence on the
Central Bank: International Evidence, The World Bank Economic Review, vol. 9., no. 3. 1995, pp. 397-423.
29 It may seem curious that disaggregated components of an index may not be statistically significant when each is
treated as an independent variable, yet they can still be significant when combined and entered as a single independent
variable. This may happen if the individual components of an index are themselves highly correlated. An assumption of
linear regression is that the independent variables are not themselves correlated. When they are, the statistical
significance of the individual independent variables can be reduced (a problem known as multicollinearity). If serious,
the variables can appear to be statistically insignificant when they are, in fact, statistically significant. This is apparently
what has occurred here.
30 Generally, economists suppose that a more variable inflation rate is correlated with higher inflation rates. And more
variability creates more uncertainty among economic agents and it is this greater uncertainty that is the real cost that
inflation imposes on an economy.

is due to the use of the short term rate on saving deposits as a proxy for a more market oriented 31
short term rate.
DF are interested in adducing evidence on whether CBs with no goal independence, but with
economic independence, as they define each term, have a better inflation record than those with
goal independence and no economic independence.
They create four indexes from those constructed by GMT and CWN to provide a range of
evidence on this issue.
Their first index is formed by using only one feature of the GMT political independence index:
the presence of a statutory requirement that the CB pursue monetary stability as a goal. They
classify this index as goal independence, and classify banks as less independent if their mandate
is more restricted (e.g., price stability as the sole goal). This is the opposite usage from the other
indices in this report. The remainder of the GMT political independence index is their second
index. Their third index consists of five components of the GMT economic independence index
(they leave out the two components pertaining to the supervisory responsibilities of CBs). Their
fourth index is the overall CWN index.
DB run five regressions for the 17 countries listed in Table 1 covering the years 1950-1989. The
only variable that is consistently statistically significant is the abbreviated GMT index of
economic independence, confirming the results found in the other studies that central bank
financing of the government’s budget deficit is the most important cause of inflation. The first DF
index is statistically significant only when it is the sole independent variable in the regression. It 322
is not significant when it is one of several independent variables in a regression. The adjusted R
for these regressions is approximately 0.45. Note also that these results are obtained from data
that are averaged across different exchange rate regimes.
Froyen and Waud (hereafter FW) begin by noting that two of the leading macroeconomic models
can provide an explanation for a short run trade-off between inflation and output
(unemployment). Their interest is whether CBI can play a role in explaining this tradeoff. They
use two CBI measures: (1) the Alesina and Summers index which, as noted above, is the derived
from the BP policy index and the adjusted total GTM index converted by AS to a BP scale, and 33
(2) the legal central bank index computed by Cukierman.

31 See Alex Cukierman, Pantelis Kalaitzidakis, Lawrence H. Summers, and Steven B. Webb, “Central Bank
Independence, Growth, Investment, and Real Interest Rates,” in Central Bank Independence, Growth, Investment, and
Real Interest Rates, Carnegie Rochester Conference on Public Policy, vol. 39, Autumn 1993, pp. 1-46.
32 As noted above, this does not preclude it from being statistically significant if it is strongly correlated with other
independent variables, in this case, the abbreviated index of economic independence. DF present no evidence on the
rank correlation between these two indexes. Thus, we have no evidence on whether a multicollinearity problem is
present in these estimates.
33 They also use an additional index computed by Cukierman, but it does not figure prominently in their discussion. It is
omitted from this discussion.

For their sample, they use the same 16 industrial countries used by AS with observations
spanning the period from the mid-1950s through the 1980s.
For the entire sample period, they find that the two measures of CBI play no role in the tradeoff.
The calculated regression coefficients of the two variables are not statistically different from zero.
When the sample is confined to the observations subsequent to 1972 (essentially the flexible
exchange rate period), the results are quite different. Both measures of CBI are statistically
different from zero and both show that CBI improves the tradeoff. That is, for a given change in
aggregate demand, the growth in output is larger and the inflation rate is lower in countries with
more independent central banks (with independence as measured above). Moreover, the fit of the 2
regression line to the data is improved dramatically (with the R increasing from .48 to .64 and
The authors are quick to point out, however, that the results are consistent with the view that
greater central bank independence may have resulted in a less activist monetary policy and,
because of that, a better output-inflation tradeoff. Were this improved tradeoff to have been
exploited, policymakers may soon find out, according to FW, that it is no better than in those
countries where more activist policy has been exercised.
Note that the findings in this study may have little to do with activist monetary policy or its
absence. What precisely the AS index measures is uncertain. The index is not broken down by
FW to show whether certain aspects of the index were driving the results. For example, it could
be that the improved inflation-output tradeoff is the result of some central banks’ not having to
finance the budget deficits of government or provide finance to certain classes of borrowers. It
may have little to do with such factors as the independence of central bank governors from the
political process.
Fuhrer uses linear regressions to test the influence of central bank independence on inflation, the
variability of inflation, and economic growth when holding other macroeconomic conditions
constant. He performs his calculations using both the Cukierman weighted CBI index and the
Alesina-Summers (AS) index. His regressions cover the period 1950-1989, making his 34
calculations vulnerable to the critique that they intermingle different exchange rate regimes.
For OECD countries, the relationship between inflation and CBI as defined by Cukierman is
statistically insignificant in both bivariate regressions and when holding other macroeconomic 352
conditions constant. In the bivariate regression, the R is only .016, meaning that over 98% of
the variation in the data cannot be explained by CBI. Using the AS countries and definitions,
Fuhrer replicates AS’s findings that in a bivariate regression the CBI-inflation relationship is 2
statistically significant, albeit with an R of only .084. However, Fuhrer demonstrates that when
controlling for other macroeconomic factors, the CBI-inflation relationship becomes statistically 2
insignificant and the R becomes very high. In some regressions, the sign on the CBI variable is
positive, suggesting that great CBI increases inflation. Fuhrer’s research suggests that the strong

34 Jeffrey Fuhrer, “Central Bank Independence and Inflation Targeting: Monetary Policy Paradigms for the Next
Millenium? New England Economic Review, January 1997, p. 19.
35 A bivariate regression is one in which the dependent variable (in this case, inflation) is explained in terms of only one
other variable (CBI). A multivariate regression explains the dependent variable in terms of several other variables.

relationship between CBI and low inflation promoted by Alesina and Summers is an artifice of
the data.
Fuhrer derives similar results when estimating the relationship between CBI and the variability of
inflation. Measured by the Cukierman index, the relationship is statistically insignificant in all
regressions and in one specification, the sign is unexpectedly positive rather than the negative. In 2
the bivariate regression, the R is .026. For the AS countries and definitions, the sign is correct for
all specifications and statistically significant in the bivariate regression. But when controlling for
other macroeconomic factors, the statistical significance of CBI disappears. This suggests that the
relationship between CBI and inflation found by other authors may be due to the correlation of
CBI with factors that the other authors excluded.
Fuhrer’s regressions between CBI and economic growth casts doubt on others’ evidence that CBI
offers a “free lunch” by allowing a country to achieve lower inflation without lower growth.
Again, most of the evidence is statistically insignificant, but in most of the regressions there is a
negative relationship between CBI and growth, including the two specifications in which CBI is 2
statistically significant. All of the growth regressions were characterized by low R values,
suggesting that the determinants of growth are more complex and poorly understood than the
determinants of inflation and inflation variability.
Campillo and Miron test the effects of CBI on inflation when controlling for a number of other
variables thought to influence inflation, such as political instability, openness to trade, and per 36
capita income using cross-sectional analysis. They use the CBI index created by Cukierman,
Webb, and Neyapti. Their measurement of inflation is the average rate from 1973 to 1994, thus
avoiding the problem of commingling exchange rate regimes discussed above. For 18 high-37
income countries, CBI has a large, negative, and statistically significant effect on inflation.
One of the main arguments in favor of CBI is that it should increase the credibility of the central
bank. Credibility is presumed to have beneficial effects on a country’s macroeconomic
performance. Specifically, it is often assumed that greater credibility will make disinflationary
episodes (periods when the central needs to tighten policy to lower the inflation rate) have less of
a negative effect on the economy. But Posen argues that central bank independence has two 38
countervailing effects on the costs of disinflation. First, there is the usual effect chronicled
above: greater central bank credibility leads to individuals adjusting their inflationary
expectations more quickly to a change in monetary policy. When prices adjust more quickly,

36 Marta Campillo and Jeffrey Miron, “Why Does Inflation Differ Across Countries? in Christina Romer and David
Romer, eds., Reducing Inflation, Motivation and Strategy, University of Chicago Press, (Chicago: 1997), Ch. 9.
37 Interestingly, when developing countries are included in the sample, Campillo and Miron find that CBI has an even
larger, statistically significant, and positive effect on inflation. This suggests either the findings for industrial countries
are not particularly robust or the effectiveness of CBI is drastically different in the developing world than the
industrialized world.
38 Adam Posen, “Central Bank Independence and Disinflationary Credibility: A Missing Link? Oxford Economic
Papers 50, 1998, pp. 335-359.

disinflation becomes less costly: tighter money supply leads to a smaller decline in output. But
Posen argues that there is a second effect working against the first: if individuals believe that CBI
makes variable inflation less likely, they would be more willing to use nominal contracts to set
wages and prices. As the use of contracts becomes more prevalent, prices and wages are less able
to adjust. In essence, people worry less about inflation when it is low, and so expectations adjust
more slowly. This would make a disinflation more costly because output must fall more to make
prices adjust. Because of these countervailing effects, he argues, it is not evident whether greater
credibility improves macroeconomic performance.
Posen uses a series of regressions to explore these questions. He defines CBI by the Cukierman-
Webb-Neyapti index and his observations are based on 17 OECD countries from 1950 to 1989,
with one observation for each decade. First, he tests the hypothesis that CBI makes disinflations
less costly. He attempts to separate the two countervailing effects by adding a separate variable
for nominal wage rigidity. The CBI variable is highly statistically significant, but it has the wrong 39
sign: increasing CBI makes disinflation much more costly in terms of higher unemployment. 2
However, few other variables are controlled for and the adjusted R tend to be moderate, ranging
from 0.249 to 0.517.
Posen then tests the hypothesis that CBI makes nominal wages more rigid. The results tend not to 2
be statistically significant and have low and even negative adjusted Rs. Moreover, the sign of the
CBI variable is not consistent across different specifications: in some cases, CBI increases wage
rigidity, in other cases it decreases rigidity. A major problem with these tests, as Posen concedes,
is that there is no consensus around a straightforward method for measuring nominal wage
rigidity, and competing measures are not closely correlated to each other. But the inconclusive
evidence that CBI increases nominal wage rigidity actually strengthens the case for CBI, since it
suggests that the fear that greater CBI would make disinflation more costly is not a strong enough
factor to be measurable.
Posen also empirically tests whether greater CBI makes disinflations faster because expectations
adjust more quickly when central banks are more credible. The evidence here is inconclusive, 2
with very low (sometimes negative) adjusted Rs and a relationship between CBI and the length
of disinflation that is mostly statistically insignificant.

39 These findings are supported by Debelle and Fischer as well as others. See Guy Debelle and Stanley Fischer,How
Independent Should a Central Bank Be?” in J. Fuhrer editor, Goals, Guidelines, and Constraints Facing Monetary
Policymakers, Federal Reserve Bank of Boston Conference Series No. 38, 1994., pp. 203-205. Cukierman offers a
rebuttal in Alex Cukierman, “Does A Higher Sacrifice Ratio Mean That Central Bank Independence Is Excessive?”
Annals of Economics and Finance, vol. 3, 2002, p. 1. Brumm and Krashevski dispute Posen’s results (among others).
They claim that much of the empirical work done in this area is deficient in two major ways. First, they claim that
Cukiermans index of central bank independence, based on legal criteria, is contaminated by serious measurement error
(meaning that it is likely to be a poor index for actual central bank independence—a fact acknowledged by Cukierman).
Second, the regressions are OLS (based on ordinary least squares). On the basis of econometric tests, they believe this
to be inappropriate. When both short comings are addressed, Brumm and Krashevshi adduce evidence that the more
independent the central bank, the lower the cost in terms of lost output and employment to reduce inflation. See
Brumm, Harold J. and Richard S. Krashevski, “The Sacrifice Ratio and Central Bank Independence Revisited.” Open
Economics Review, vol. 15, 2004, pp. 385-402. The negative relationship was also confirmed by Diana and
Sidiropoulos, who were interested in the relationship between central bank independence and inflation persistence. See
Diana, Guiseppe and Moise Sidiropoulos, “Central Bank Independence, Speed of Disinflation, and the Sacrifice Ratio,”
Open Economies Review, vol. 15, 2004, pp. 385-402. A potential shortcoming of both studies is that they commingle
the data from fixed and flexible exchange rate regimes.

In recent years, the literature on central bank independence has multiplied. In 1996, Eijffinger and
de Haan surveyed 17 empirical studies on the effects of CBI on inflation that included developed 40
countries. (Six of the 17 studies are discussed at length in this report.) Fifteen of the 17 studies
found that CBI lowers inflation, while the other two found that the relationship was not
significant. Some of the studies confirm that the link between CBI and inflation was weaker
during the Bretton Woods period (prior to the early 1970s), when the primary objective of central
banks was the maintenance of fixed exchange rates, and inflation stability was a secondary
objective. Of the studies that examined the relationship between CBI and inflation variability,
seven found that CBI decreases variability, two found that it did not, and three had mixed results.
Most of the studies that examined the relationship between growth and CBI found no
In 2001, Berger, de Haan, and Eijiffinger surveyed 30 more empirical studies written since the
1996 survey on central bank independence that include developed economies. They describe the
literature as “extensive evidence suggesting that CBI helps to reduce inflation,” particularly for 41
advanced economies. Of the 30, 15 of the studies reviewed reaffirm that CBI lowers inflation.
However, eight studies did not find a link between inflation and CBI, or found that the correlation
is caused by some third variable. (Three studies had mixed results and four did not address the
question.) Some studies found that CBI has a more (statistically and economically) robust effect
on inflation in certain time periods than others and for certain measures of CBI. While the newer
studies confirm the findings of the earlier ones on balance, scholarly dissent on the CBI issue is
The independence of CBs is now touted as important in a country’s quest for low inflation. A
number of studies have established the relationship, and claim that it occurs without deleterious
effects on such important indicators of economic performance as real output growth, the
variability of that growth, investment, and the level and variability of real interest rates.
There are, however, a number of different definitions attached to the term “central bank
independence.” As the different indexes show, the term encompasses a range of meanings from
the methods of selecting and isolating the governing board from political influence, to
determining the CB’s objectives, and whether CBs can be used to finance government budget
The review of the empirical evidence suggests that for industrial countries a case can be made
that the rate of inflation is negatively related to those provisions of CB charters that circumscribe 4243
CB lending to governments. It is difficult to make a case, however, for factors such as the

40 Sylvester Eijffinger and Jakob de Haan, “The Political Economy of Central Bank Independence, Princeton Special
Papers in International Economics, no. 19, May 1996.
41 Helge Berger, Jakob de Haan, and Sylvester Eijffinger, “Central Bank Independence: An Update of Theory and
Evidence,Journal of Economic Surveys, vol. 15, no. 1, 2001, p. 3.
42 There is also a large literature focusing on the effects of CBI in developing countries that is beyond the scope of this

selection of the governing board and its isolation from the political process or use of inflation 44
targeting. Although evidence from DF suggests that a formal price stability goal may be of some
importance to the established relationship, it is not robust.
Thus, the evidence for industrial countries supports a highly selective use of the term “central
bank independence.” Based on this evidence, it would, perhaps, be more accurate to say that
when a nation’s treasury has only limited access to the resources of its central bank, low inflation
is likely to result. Moreover, the CBI literature has been criticized in a number of ways that are
described in the next section.

An econometric study is only as good as the assumptions underlying it. Legitimate questions have
been raised about the way these studies have been conducted that casts doubts on their findings.
The empirical work reviewed above suggests the direction of causation prevailing in the minds of
their authors. The estimating equation the authors use to establish their empirical results reflects
this view. Clearly, in these studies, movements or differences in the various CBI indexes are
viewed as explaining or causing, in part, the different behavior observed across industrial
countries in the inflation rate, the variance in that rate, output growth, the variance in output
growth, investment, real interest rates, etc.

report. See Prakash Lougani and Nathan Sheets, “Central Bank Independence, Inflation, and Growth in Transition
Economies, Journal of Money, Credit, and Banking, vol. 29, no. 3, August 1997, p. 381; Wojciech Maliszewski,
Central Bank Independence in Transition Economies,” Economics of Transition, vol. 8, no. 3, November 2000; Luis
Jacome, Legal Central Bank Independence and Inflation in Latin America During the 1990s, International Monetary
Fund, Working Paper no. 1/212, December 1, 2001; Bernd Sikken and Jakob de Haan, “Budget Deficits, Monetization,
and Central Bank Independence in Developing Countries, Oxford Economic Papers, vol. 50, no. 3, July 1998, p. 493;
Jakob de Haan and Willem Kooi, “Does Central Bank Independence Really Matter? New Evidence for Developing
Countries Using a New Indicator, Journal of Banking and Finance, vol. 24, no. 4, April 2000, p. 643.
43 In a comprehensive study of 163 central banks as of the end of 2003 disaggregated by the state of development of the
respective countries, Arone, et. al., report on trends in CBI over the past several decades, the degree to which increased
CBI has contributed to the improved inflation performance of most economies, and the lessons learned from this
experience. Their empirical results show that increased independence (or, using their word, autonomy) has been one of
several factors that has played a role in the improved inflation performance among the countries comprising the world
economy (as has the nature of the exchange rate regimefixed exchange rates improve the chances for obtaining low
inflation). See, Arone, Marco, Laurens, Bernard J., Segalotto, Jean-Francois, and Martin Sommer, Central Bank
Autonomy: Lessons from Global Trends,” IMF Working Paper (April 2007).
44 Carlstrom and Fuerst, using data from industrialized nations, report that the average rate of inflation experienced by
countries whose central bank operate under an inflation target mandate since 1990 was 2.5%, compared to 2.9% for
those countries without such a central bank mandate (both groups of central banks had about the same average level of
independence). The inflation rate difference is not statistically significant, meaning that it is entirely consistent with
pure chance. See Carlstrum, Charles T. And Timothy S. Fuerst, “Central Bank Independence: The Key to Price
Stability? Economic Commentary, Federal Reserve Bank of Cleveland, September 1, 2006.

While few individuals would doubt that political institutions, events, and developments can have
a profound effect on how well an economy functions, many would argue that causation can, in
fact, run in the opposite direction from that implicitly posited in the above studies or that two way
causality may be present (which is, incidently, acknowledged by the authors of these studies).
Thus, for example, a fear of inflation can lead countries to establish and maintain very
independent central banks and forbid them to directly or indirectly lend to government. To be
more specific, as Walsh points out, “high inflation, if viewed as an indication of failed central
bank policy, might lead to the replacement of the central banker—in this case high CEO turnover 45
is not necessarily a reflection of low CB independence causing inflation.”
Alternatively, a desire for economic stability can also cause political institutions to emerge and 46
evolve in ways that ensure such an outcome. In this case, CB independence can be thought of as
being correlated with an omitted variable, “responsible governance,” that is the true cause of low
inflation. If this is the case, governments who lack “responsibility” could make their central banks
statutorily independent and still not achieve low inflation. For example, Posen theorizes that what
matters most in achieving low inflation is effective support by an important constituency, such as
the financial sector. One of the policy changes such a constituency might demand to achieve low 47
inflation is central bank independence, attributing spurious causation to CBI.
Thus, a general methodological criticism directed against all of these studies is that they have not
demonstrated convincingly that causation runs in the direction they have hypothesized. Hence,
institutional reforms along lines suggested by these authors may not yield the benefits suggested
by this body of empirical work.
Forder raises other methodological criticisms of the studies.48 The studies all define independence
by ranking the central banks on the basis of a number of legal characteristics. CBs that possess
more of these characteristics are ranked as more independent. He argues that the studies
arbitrarily look for legal characteristics of central banks that all low inflation countries happen to
share. There is no a priori attempt to define which characteristics are necessary for independence
and which characteristics are more important than others. He argues that the studies have tended
to arbitrarily assume that characteristics uncorrelated to inflation are not important for

45 Carl Walsh, “Central Bank Strategies, Credibility, and Independence, Journal of Monetary Economics, vol. 32,
1993, p. 296.
46 Posen, for example, has made the case that the financial sector in many industrial countries, because it highly prizes
price stability, has emerged as a major force persuading governments to establish and maintain independent CBs. Thus,
it is the financial sector and its desire for price stability that causes that outcome to prevail. The means to achieve this
end is an independent CB. See Adam Posen, “Why Central Bank Independence Does Not Cause Low Inflation: There
Is No Institutional Fix for Politics,” in Finance and the International Economy: No. 7. OBrien, Richard, ed. (Oxford:
Oxford University Press, 1993), pp. 40-65; and Adam Posen,Declarations Are Not Enough: Financial Sector Sources
of Central Bank Independence” in NBER Macroeconomic Annual for 1995, edited by B. Bernanke and J. Rotemberg
(Cambridge: MIT Press, 1995), pp. 253-274. There are, of course, other possible reasons a country would want a more
independent CB. Many of these other factors are discussed and the empirical evidence offered about them evaluated in
Sylvester Eijffinger and Jakob de Haan, “The Political Economy of Central Bank Independence, Princeton Special
Papers in International Economics, no. 19, May 1996.
47 Adam Posen, “Declarations Are Not Enough: Financial Sector Sources of Central Bank Independence, in Ben
Bernanke and Julio Rotemberg, eds., NBER Macroeconomics Annual (Cambridge, MA: MIT Press, 1995).
48 James Forder, “Central Bank Independence: Reassessing the Measurements, Journal of Economic Issues, vol. 23,
no. 1, March 1999, p. 23.

independence, and vice versa, making the studies self-fulfilling prophecies of the hypothesis that
independence reduces inflation. For example, it is not clear that a price stability goal should be
defined as independence since it limits the CB’s discretion, but since it is correlated with low
inflation, it bolsters the findings that independence matters. He points out that—besides Germany
and Switzerland—there is no consensus among the different studies as to which countries have an
independent central bank. If different studies cannot agree on what makes a CB independent, how 49
can the studies prove that independence leads to low inflation?
The strong relationship between independence and low inflation in Germany and Switzerland,
and the absence of a strong relationship elsewhere, raises the question of whether there is some
other factor that caused low inflation in those two countries. In fact, both countries had a long
series of nearly balanced budgets during the period 1950s-1980s, removing a source of upward
pressure on interest rates. Bernanke et al. offer another explanation: both countries targeted the
growth rate of the money supply well before other countries had adopted restrictive mandates 50
such as a sole goal of price stability. Either of these factors, rather than independence, could be
the true cause of their low inflation.
Nor is there any attempt in many of the studies to evaluate whether the statutory independence
granted to the banks is maintained in reality. For example, two different countries could grant
their banks the same statutory autonomy from the elected government, but in practice one
government could pressure the CB from behind the scenes to influence policy while the other
respected its independence. In these studies, the two central banks would be ranked equally 51
independent. Cukierman and Webb try to get around this problem by looking at the turnover rate 52
of the CB CEO and survey evidence, but the results from this study are inconclusive. Survey
evidence about specialists’ perceptions of a central bank’s independence have almost no
correlation to CWN’s legal definition of independence. This indicates that legal measures of 53
statutory independence may be misleading.
Finally, the studies could be questioned on econometric grounds. The studies assign numerical
values to non-numerical legal characteristics. For example, for the question of how the chairman
of the CB is appointed, CWN assign a value of 1 if appointed by the board of the central bank,
0.75 if appointed by the board, legislature, and executive, 0.5 if appointed by the legislature, 0.25
if appointed by the executive collectively, and 0 if appointed by one or two members of the
executive. The studies then use the ordinary least squares method to regress those numerical
values on inflation to test for correlation. The econometric problem with this method is that the

49 Mangano points out that 40% of the characteristics that define independence in the GMT index are not included in
the Cukierman index, and 45% of the characteristics in the Cukierman index are not included in the GMT index. G.
Mangano, “Measuring Central Bank Independence: A Tale of Subjectivity and Its Consequences,” Oxford Economic
Papers, vol. 50, 1998, p. 468.
50 See Ben Bernanke et al, Inflation Targeting (Princeton, NJ: Princeton University Press, 1999), Ch. 4.
51 James Forder, “On the Assessment and Implementation of ‘Institutional’ Remedies,” Oxford Economic Papers, vol.
48, 1996, p. 39.
52 Alex Cukierman and Steven B. Webb, “Political Influence on the Central Bank: International Evidence,The World
Bank Economic Review, vol. 9., no. 3. 1995, pp. 397-423.
53 Carl Walsh, “Central Bank Strategies, Credibility, and Independence, Journal of Monetary Economics, vol. 32,
1993, p. 295.

numerical values may not be proportionately related. For example, for a regression to be
econometrically valid, a central bank that receives a grade of 2 should be twice as independent as
a bank that receives a grade of 1, and have twice the estimated effect on inflation. But since the
values are based on non-numeric characteristics, there is no way of knowing whether it is
reasonable to assume that a a CB with a grade of 2 would have twice the effect on inflation as a
CB with a grade of 1. The weighting of the various characteristics will also be important in the
regression results. It may be that only a couple of characteristics really define independence. If
those factors are equally weighed with all characteristics, the index will not reflect true
independence and the regression results will be biased.
Furthermore, there are econometric problems with the sample itself. If limited to advanced
economies, then the sample will be small and homogeneous, and thus may not offer enough
variation in terms of CBI and economic outcomes to yield meaningful regression results. If
developing countries are included, the sample becomes large and diverse, but runs the risk of
finding spurious correlation between inflation and CBI by omitting more important factors than
CBI (corruption, weak legal system, market interference, etc.) that explain the diversity of
economic outcomes.
Finally, a time-series study is only valid if the relationship between the variables is stable over
time. Much of the evidence is tainted because it is obtained from an analysis that commingles
data from fixed and flexible exchange rate periods. And there is substantial reason to believe that
the different exchange rate regimes can affect the permissible range of CB behavior. The fixed
exchange rate regime was in existence from 1950 through the early 1970s, whilst subsequent
years would have been in the flexible rate period. Under a fixed rate regime, central bank
independence, as measured by BP and others, doesn’t really mean much. Regardless of whether
the central bank is directed to maintain a low inflation rate or a constant price level, it must,
above all else, maintain a fixed exchange rate. So long as this goal has primacy, it is of little
importance how its price level directive is framed. Under a flexible rate regime, an inflation goal
can be pursued without the constraint of the exchange rate requirement. For the same reason,
evidence obtained from European countries that fixed their exchange rate to the Deutschmark in
recent decades should be discounted. It should also be noted that central bank independence
changes over time in ways that some of the studies may not capture. For instance, the central
banks of New Zealand and Great Britain have become much more independent over the last

Much has been made of the empirical finding that central bank independence is negatively
associated with the rate of inflation and that this comes as a “free lunch” in terms of no adverse
effects on some very important and desirable performance characteristics of an economy.

Yet, as demonstrated above, the phrase “central bank independence” is quite imprecise. As used
in the literature, the phrase applies to three aspects of independence:

1. the degree to which the CB’s governing board is isolated from the political process;

2. the degree to which central banks can refuse to monetize public debt, i.e., finance the
3. the degree to which price stability has a primacy as the ultimate goal of central bank
When these three aspects of independence were tested against the rate of inflation, for example,
(1) and (3) were often combined into one variable. Only Debelle and Fischer used meaning (3) as
a separate independent variable. And they found that it had a negative role to play in explaining
inflation that was sometimes statistically significant. Thus, the DF result lends some support to
those who seek to redefine the mandate of the Federal Reserve, or in the words of DF, to take
away goal independence from the Federal Reserve (the other indices would classify (3) as
increasing independence). This, of course, presupposes that causality runs in the direction
assumed by DF.
The variables included in (1) were seen to have no statistically significant effect on the indicators
of economic performance. From this, one could conclude that to add the Secretary of the
Treasury, for example, to the Board of Governors of the Federal Reserve would, presumably, have
no measurable effect on the indicators of economic performance.
A variable designed to capture the essence of definition (2) did turn up in all of the studies as
statistically significant. Presently, however, the Federal Reserve is forbidden to purchase other 54
than seasoned U.S. government securities. It cannot directly purchase new Treasury issues. The
empirical studies suggest that this feature of U.S. law contributes to a low rate of inflation.
Proponents argue that the empirical evidence suggests that Congress may, in the discharge of its
oversight responsibilities for monetary policy, want to make the policy goal of the Federal
Reserve more specific. It may, they argue, wish to replace the current multi-goal directive with
one directing the Federal Reserve to achieve and maintain price level stability, characteristic (3).
Some would argue that the evidence is not robust enough, and the direction of causality is
incorrect, to base such a policy change on, however.

54 Do not confuse financing the government with open market purchases, the major way by which the Federal Reserve
conducts monetary policy and puts currency into circulation. Open market operations involve the purchase and sale of
U.S. government securities with the objective of altering the reserve position of U.S. banks, and through it, money and
credit conditions prevailing in the economy. The data show that these purchases have not been used as a means for
financing the deficit of the federal government. Between 1980 and 1996, for example, federal debt held by the public
rose by approximately $3 trillion. During this same period, federal debt securities held by the Federal Reserve rose by
about $280 billion, or a little less than 10% of the increase. And most of these securities were required as backing for
the paper currency put into circulation.

The emphasis in much of the body of research reviewed above is to establish the importance of
central bank independence as a factor explaining differences in the rates of inflation among
countries as well as differences in other major indicators of economic performance. This is
accomplished by the use of linear regression. To appreciate the conclusions reached by these
researchers, it will be helpful to have an elementary understanding of this research tool.
Equations estimated by linear regression take their form from some hypothesized relationship in
which the behavior of one or more variables (the independent variables) is held to influence some
other variable (the dependent variable). The application of regression analysis involves fitting a
straight line to a group of observations, usually a sample selected from the universe of those
variables, that are suggested by the hypothesized relationship. The straight line is fitted such that
the deviations of the actual observations from those suggested by the straight line are minimized.
The value of the slope of that line then gives the effect of the independent variable (or variables)
on the dependent variable.
While the calculated value of the slope of the line may be positive or negative (or even zero), it’s
true value may not be statistically significantly different from zero. Because this is so, it will be
necessary to briefly discuss what is meant by a calculated value being “statistically significant.”
To understand statistical significance, let us say that the calculated effect of the independent
variable on the dependent variable is .10. Thus, changes in the independent variable by one unit
change the dependent variable by .10. This assumes, of course, that the value .10 is really
different from zero. Recall, that it was calculated, not from the universe of the independent
variable, but from a sample taken from that universe. Thus, it is possible that our assumption that
the true value of the effect of this variable on the dependent variable is different from zero is
wrong. It is, however, possible to control for making this type of error—that is, for accepting as
true a relationship that is, in fact, not true. It is common to set the control factor at 1 to 5 chances
in 100 of accepting the hypothesis that the variable is different from zero when it is not. If the
calculated value of the independent variable lies within a range that limits the error to 1% to 5%,
it is said to be statistically significant (or statistically significantly different from zero).
Since the purpose of this study is to establish the importance of central bank independence as a
factor affecting a range of variables by which we judge economic performance, one other 2
summary statistic must be explained: goodness of fit or R.
The R2 is designed to measure the fraction of the variation of the dependent variable that is 2
explained by the variation of the independent variable(s). The R ranges in value between 0 and 1. 2
The higher the R is, the larger is the proportion of the variation in the dependent variable that is
explained by the variation of the independent variable(s).

Marc Labonte Gail E. Makinen
Specialist in Macroeconomic Policy
mlabonte@crs.loc.gov, 7-0640