Central Bank Independence in Transition Economies

1. Central Bank Independence (CBI) in Economic 

Theory 

This chapter presents theoretical basis for Central Bank Independence. The main 

conclusion from the theory is that greater CBI may reduce “inflationary bias” in the 

economy, i.e., persistent and higher than socially optimal price growth. For 

understanding the possible causes for the bias, first section demonstrates the benefits 

from unanticipated inflation produced by policymakers. Following Cukierman (1992) 

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W. Maliszewski 

CASE Foundation 

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four possible motives for monetary expansion are investigated: employment, revenue, 

balance of payment and financial stability motive. In the second section the basic 

monetary policy game model and the concept of time-inconsistency are introduced 

together with the recent theory of Political Monetary Cycles. Imperfect information 

and the credibility solution to the time-inconsistency problem are discussed in the third 

section. Various institutional solutions, which are crucial for understanding the role of 

CBI, are presented next. The Rogoff's (1985) argument for conservative Central 

Banker is examined in section four and the concept of the Walsh (1995) contract in 

section five.