Central Bank Independence in Transition Economies

 

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W. Maliszewski 

CASE Foundation 

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Central Bank Independence… 

S&A No. 120 

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Introduction 

The newly established central banks in post-communist countries were provided 

with a considerable degree of legal independence. The reason for that was the 

empirical success of independent banks in developed countries in maintaining price 

stability. Theoretical support for independent central bank originates from the well 

known result on dynamic inconsistency of monetary policy (Kydland and Prescott 

1977). Delegating monetary policy to “conservative” central banker reduces the 

inflationary bias in economy (Rogoff 1985). High and persistent inflation is one of the 

main problem faced by the transforming economies. Monetary expansion driven by 

political factors seems to be the main cause of current inflationary episodes. 

Institutional devises, such as an independent central bank, can impose necessary 

financial discipline on policymakers and restrict them from short-sighted monetary 

expansion. Of course, legal independence does not necessarily result in the actual 

independence i.e., effective protection from the political pressure. The legal provisions 

may be ineffective because observance of the law, the main public good in developed 

society, has been destroyed under the communist rule. The new institutions 

“transported in the suitcases of Western advisors into largely insolvent and 

administratively weak states” (Semler 1994) may not be able to withstand the political 

pressure of the transition period. Macroeconomic imbalances, credit-hungry 

governments and underdeveloped financial system produce an environment in which 

the CB independence is thoroughly tested. However, even in these circumstances, 

proper institutional settings are likely to reduce discretion in monetary policy and 

create sound foundation for political and economic transformation. 

The aim of this paper is to examine the legal independence of the Central Banks 

and its influence on inflation in 10 Central European countries and former Soviet 

republics. The paper is organised as follows. First, possible motives for monetary 

expansion, its influence on inflation and the role of central bank in reducing 

inflationary bias are presented. The next chapter briefly describes previous empirical 

works on central bank independence and its impact on inflation. Then, various aspects 

of central bank independence in transition countries are presented and an overall index 

of independence is derived. Relations between independence and macroeconomic 

performance are examined next. Finally, I give some conclusions.