Central Bank Independence in Transition Economies

Central Bank Independence… 

S&A No. 120 

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4. Conclusions 

This paper discusses the role of institutional arrangements in anti-inflationary 

policy in transition economies of Central Europe and former USSR. The economic 

theory explains various motives for excessive monetary expansion. Policymakers can 

be tempted to increase employment above the natural level, collect the seignorage 

revenue, improve the balance of payment position or stabilise the financial system. 

The first motive is not very important in the high inflation environment which is 

characteristic for transition period. Other motives have significant effect on the 

inflationary history in post communist countries. Revenue motive seems to be crucial 

for understanding the excessive monetary expansion. The theory predicts that the 

temptation to use monetary policy combined with rational expectations of the private 

agents results in inflationary bias in the economy. People know the policymakers' 

goals and adjust to it by higher inflationary expectations. The optimal policymakers' 

response is to inflate at the rate expected by the people. The resulting equilibrium is 

sub-optimal, i.e., the inflation is higher and there are no real gains for the society. The 

solution to the problem is delegating monetary policy to the independent and 

conservative Central Banker. The paper investigates the degree of Central Bank's 

independence (CBI) in transition countries by constructing two indices of legal 

independence. The results show that the countries more advanced in reforms seem to 

have more independent Banks. In further analysis a strong relationship between 

inflation performance and the legal CBI emerges. However, the outcomes of the 

statistical procedures have to taken with caution. Firstly, the sample under 

investigation is small and the time horizon is too short to draw any decisive 

conclusions. Secondly, the transitional economies are at different stages of reforms 

and the differences in inflation performance may be affected by other factors. Thirdly, 

the results do not imply causality between CBI and inflation. The independence might 

be upgraded after the successive stabilisation. The possible extension of the 

quantitative analysis may be investigation of the duration of the disinflationary 

process. This is left for further research. 

It is important to note that the problem of CBI is wider than the concept of legal 

independence. To fully assess the Central Bank performance it is necessary to look at 

the actual independence, i.e., take into account the degree of adherence to the law in 

practice. The behavioural indices of CBI proposed in the literature are based on 

Governors' turnover rate or on the vulnerability of the Governor to political changes. 

These two measures reflect the political independence of the Bank. The economic 

independence may be evaluated by comparing the legal limits on lending to the 

Government with actual practice. The problem of actual CBI will be investigated in 

further research. 

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