Central Bank Independence in Transition Economies

W. Maliszewski 

CASE Foundation 

20

balance of payment motive. Political pressure of well-organised lobbies on 

“competitive devaluation” is very strong in many transition economies. Stability of  

the financial system seems to play an important role as well, but the precise 

mechanism of this relation is not well examined. In some transition countries (e.g., 

Bulgaria) Government securities are the main source of financial sector's profits. The 

high yield on these papers protect commercial banks from losses caused by the large 

amount of bad loans in their portfolios. Thus the theoretical model presented in section 

1.4 is not applicable in this case and the problem requires further investigation. 

Generally, well documented theoretical determinants of inflationary bias operate in the 

transition countries and the Rogoff's solution to the excessive inflation problem, 

delegation of the monetary authority, should perform well in post communist 

economies. 

Instead of high degree of legal independence, several features of the transition 

economies might affect central bank behaviour and distort the influence of legal 

independence on inflation performance (Cukierman 1996): 

– 

Initial stage of the economic transformation was characterised by severe 

macroeconomic imbalances. Price liberalisation and initial devaluation of the 

currency produced substantial shocks to the economy and need for monetary 

accommodation of these shocks. 

– 

Inefficient “welfare state”, loss-making state-owned enterprises and tax base 

erosion produced substantial pressure on the States' budgets. In the presence of 

narrow domestic financial markets and limited access to foreign financial markets 

(due to high indebtedness), the emerging deficits could only be financed by the 

Central Banks. Thus, inability to balance the budget in some transition economies 

resulted in high inflation in spite of legal CBI. 

– 

Banking systems in transition economies inherited considerable amount of non-

performing loans. Newly developed private financial institutions were fragile and 

unstable. The Central Banks, usually legally responsible for financial stability, were 

forced to bail out insolvent banks in order to avoid financial crisis. The price for the 

rescue operations was additional monetary expansion. 

– 

The norm of general adherence to the law has been destroyed under the communist 

rule (Triska 1994). In the presence of shocks described above, there is a temptation 

to bend the law. Thus, the legal provisions may be insufficient to protect CBI from 

the political pressure. 

Nevertheless, it may be argued that the tremendous pressure exerted on Central 

Banks in transition environment makes the appropriate legal framework even more 

important for sound Bank's operations than in developed countries.