Central Bank Independence in Transition Economies

W. Maliszewski 

CASE Foundation 

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to keep the real wages on the desired level. The resulting equilibrium will be analysed 

in section 2. 

1.1.4. Financial Stability and Monetary Expansion 

One of the Central Bank's main tasks in most of the countries is a stability of the 

financial system. Cukierman (1990, 1992) shows that this objective may be 

inconsistent with price stability and results in the inflationary bias. In his model the 

Central Bank cares about the price stability and, to assure stability of the financial 

system, about the profits of the banking sector. It may be shown (Cukierman 1990, 

sec. 3) that these profits decreases with the real rate on Government bonds

1

. The 

Central Bank may temporary reduce this rate by increasing the monetary expansion 

and providing additional liquidity to the banking system. Thus there is a trade off 

between stability of the financial system and inflation. The Central Bank's concern for 

the banking sector stability results in excessive rate of monetary expansion and, 

consequently, higher inflation.