Central Bank Independence in Transition Economies

3.1. Specific Features of Transition Economies 

Economic reforms in post-socialist countries required deep institutional reform of 

the existing banking system. Pre-transformation system was based on the monobank, 

the central institution responsible for administering transaction and issuing cash and 

credit in centrally planned economy. Market reforms required creation of the two-tier 

banking system and separating Central Bank from commercial banking activity. In 

most of the countries the establishment of the Central Banks took place at the 

beginning of the transformation. New law granted a substantial statutory independence 

from other state's institution to the established or re-established Banks. The new 

statutes were based on the charters of the most independent Western Banks. The most 

important question in this research is whether the high degree of independence 

resulted in a downward pressure on inflation in transition economies. Two problems 

arise: how the economic theory presented in the first chapter fits to transition 

economies and how legal provisions are effective in practice. 

The main theoretical determinant of the inflationary bias, namely the 

employment motive for monetary expansion, seems to have only limited influence in 

transition environment. The high or very high inflation significantly reduces the length 

of nominal contracts and brings various mechanisms of indexation. The dominant 

factor of persistent inflation in post communist countries is certainly the revenue 

motive. Severe fiscal imbalances and narrow financial markets inevitably lead to the 

monetary deficit financing. Another important source of inflationary pressure is the 

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