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Central bank reform liberalization and inflation in transition economiesF
Abstract
Abstract This paper develops extensive new indices of legal independence,(central bank,independence (CBI)) for new,central banks,(CBs) in 26 former,socialist economies.,The indices reveal that CB reform,in the FSE during the 1990s has been quite ambitious. In spite of large price shocks, reformers in those countries chose to create CBs with levels of legal independence that are substantially higher, on average, than those of developed economies during the 1980s. The evidence in the paper shows,that CBI is unrelated to inflation during the early stages of liberalization. But for sufficiently high and sustained levels of liberalization, and controlling for other variables, legal CBI and inflation are significantly and negatively related. These findings are consistent with the view that even high CBI cannot contain the initial powerful inflationary impact,of price decontrols. But once the process of liberalization has gathered sufficient momentum,legal independence,becomes,effective in reducing,inflation. The paper This is a revised version of CEPR Discussion Paper number 2808, May 2001. Previous versions of the
... 4 Our estimations strongly support 3 The Wall Street Journal Europe, 1/ 20/2010: " Weber seen in ECB race " ; " King warns on deficit " . 4 Previous CBI data is aggregated to decade averages (Grilli et al. 1991, Cukierman et al. 1992) or focuses on single regions (Cukierman 2002, Jacome and Vasquez 2008, Bodea 2013), two points in time the argument: Democracies with independent central banks have lower fiscal deficits and this effect is driven both by constraints on the executive and by media freedom. We also find that, in democracies, CBI reduces fiscal deficits in non-election years and during the tenure of left-wing executives. ...
Independent central banks prefer balanced budgets due to the long-run connection between deficits and inflation, and can enforce their preference through interest rate increases and denial of credit to the government. This article argues that legal central bank independence (CBI) deters fiscal deficits predominantly in countries with rule of law and impartial contract enforcement, a free press and constraints on executive power. It further suggests that CBI may not affect fiscal deficits in a counter-cyclical fashion, but instead depending on the electoral calendar and government partisanship. The article also tests the novel hypotheses using new yearly data on legal CBI for seventy-eight countries from 1970 to 2007. The results show that CBI restrains deficits only in democracies, during non-election years and under left government tenures.
... In each analysis, the annual average consumer price inflation rate serves as the primary dependent variable+ 28 The use of an inflation measure creates two related theoretical and empirical concerns: how to deal with incidents of negative inflation and how to compensate for outliers+ Although negative or low inflation rates have recently reemerged as a concern, our theoretical discussion of monetary policy commitments centers on preventing high levels of inflation+ 29 Therefore we explicitly focus on the positive observations of inflation, which constitute over 95 percent of the sample's consumer price inflation rate observations+ Excluding negative inflation rate observations simplifies the treatment of outliers+ While the mean inflation over the sample period is in the single digits~8+4 percent!, almost 4 percent of observations exceed three digits+ As is common, we constrain the influence of such outliers by logging inflation rates+ 30 As a robustness check, we implement an alternative depreciation-based mechanism suggested by Cukierman and his col-leagues+ 31 The results are briefly noted with other robustness checks+ 28+ Data from World Bank 2007+ A common alternative measure of inflation, the annual deflation rate for GDP~World Bank, 2007! is highly correlated~0+99 for this sample!+ 29+ On low or negative inflation rates, see Bernanke 2003+ 30+ See, for example, Broz 2002+ 31+ See Cukierman, Webb, andNeyapti 1992;Cukierman and Lippi 1999;and Cukierman, Miller, and Neyapti 2002+ The main independent variables are based on classifications of countries' de jure and de facto exchange rate regimes+ Since 1974, the IMF has published a summary of countries' de jure exchange rate policies in its Annual Report on Exchange Rate Arrangements and Exchange Restrictions+ 32 For our analysis, we focus on a simple distinction between fixed and floating+ "Fixed" encompasses pre-announced policies that limit flexibility: no separate legal tender, pegs or currency board arrangements, crawling pegs, and narrow crawling bands~narrower than or equal to ϩ0Ϫ 2 percent!+ "Floating" includes both "managed floats" in which central banks may intervene to avoid excessive volatility in exchange rates, possibly by setting wide crawling bands~wider than ϩ0Ϫ 2 percent!, and pure floats with no direct intervention+ In 1999, the IMF moved from a classification system based solely on countries' stated intentions to a classification system that incorporates IMF analysts' judgment on the actual regime, noting in footnotes perceived de facto discrepancies from de jure policies+ For observations from 1999 to 2004, where discrepancies were noted, we used the detailed text from the country pages to code de jure policy+ As noted below, we undertake a robustness check to ensure that our post-1998 coding does not affect our results+ ...
If governments choose economic policies that often run counter to their public commitments, are those commitments meaningless? We argue that government proclamations can be critical in signaling economic policy intentions. We focus on the realm of exchange rate policy, in which countries frequently implement an exchange rate regime that differs from the officially declared regime. We argue that the official exchange rate regime is one of the most important signals of a government's economic policy preferences. When a government makes a de jure public commitment to a fixed exchange rate, it sends a signal to domestic and international markets of its strict monetary-policy priorities. In contrast, a government that proclaims a floating exchange rate signals a desire to retain discretion over monetary policy, even if it has implemented a de facto fixed rate. We use data on 110 developed and developing countries from 1974 to 2004 to test two hypotheses: first, that governments that adopt de facto fixed exchange rates will experience less inflation when they back up their actions with official declarations; and second, that governments that abide by their commitments will establish greater inflation-fighting credibility. Within developing countries, democratic institutions enhance this credibility. Results from fixed-effects econometric models provide strong support for our hypotheses.
In the substantial literature on central-bank independence (see the comprehensive surveys by Eijffinger and de Haan, 1996, and Alex Cukierman, 1998), two primary empirical issues are (1) measurement of central-bank independence to be able to determine the degree to which a central bank is independent and (2) evaluation of the relation between a measure of central-bank independence and policy performance.
"This article extends the model of Von Hagen and Harden that analyzed the impact of fiscal discipline on budgetary outcomes. We modify the model by adding monetary discipline to interact with fiscal discipline in order to analyze the effects of both on budgetary outcomes. The model predicts that while both inflation and budget deficits are negatively associated with fiscal discipline, they may be positively associated with monetary discipline, proxied by central bank independence. This result obtains due to optimizing agents internalizing the burden of spending: inflation. Although not conclusive due to data limitations, empirical findings also support these predictions. "("JEL "D73, E58, H61, H72) Copyright 2007 Western Economic Association International.
Institutions and policies
Vittorio Grilli, Donato Masciandaro and Guido Tabellini
Why do countries as similar as the industrialized OECD countries go through such different experience in terms of public deficits and debts or in terms of inflation? The answer cannot come from macroeconomic policy responses to different disturbances, nor from the principles of optimal taxation, but rather from politics. This article focuses on the role that particular institutions exert in providing constraints and incentives which shape the actions of policymakers. The electoral process and political traditions affect the ability of governments to deal with deficits and mounting debts. What seems to matter most, it is found, is the effect of the durability of governments. Governments with short horizons act myopically and never quite tackle the hard choices. Such governments typically exist in countries with an electoral system favouring many small political parties. Central bank independence promotes low inflation with no apparent costs in terms of real economic performance, irrespective of the political institutions. In fact there is no link between monetary and fiscal discipline. These findings carry powerful implications for countries facing high indebtedness or stubborn inflation, but also for the construction of the European Economic and Monetary Union.
The paper examines the relations between central banks and other macro sectors in the Czech Republic, Hungary, Romania, with respect to the creation and distribution of seigniorage, taking Austria and Germany as a reference. In economies in transition, transfers of seigniorage from the central bank to the government and to the banking sector may appear as a natural way to soften the financial constraints of both sectors.We propose a simple framework for the analysis of central bank seigniorage, based on the opportunity cost approach, and measure both the amount and allocation of seigniorage for the five countries in 1993. We find central bank seigniorage to be approximately four times our benchmark value in Hungary, and thirty times in Romania (the latter due to the high level of the inflation tax). In Hungary and Romania most seigniorage is appropriated (as an interest rate subsidy) by the government; in Romania a large part also goes as a subsidy to the financial sector. In none of the five countries we find that central banks retain an excessive amount of seigniorage for reserve accumulation or for current expenditures.In the last part of the paper we discuss the implications of our findings on seigniorage for the evaluation of central bank independence vis-à-vis the government.
In analyzing the transitional experience of countries in Central and Eastern Europe (CEE) and the former Soviet Union (FSU), the authors find strong common patterns for countries at similar stages of reform despite differences in initial conditions. To establish rankings, the authors create a reform index combining the intensity and duration of economic liberalization. Freeing domestic prices is one element of reform captured by the index; it was needed to enable governments to cut subsidies and restore macroeconomic balance. Other dimensions of reform captured by the index are liberalization of external trade, including foreign currency convertibility, and facilitation of private sector entry through privatization of state enterprises and improvements in the environment for private sector development. Some countries moved faster on reform than others, and one major reason appeared to have been the pace of political liberalization. Liberalization has, indeed, encouraged capital and labor to reallocate from industry toward services, many of which were previously repressed; and the repressed sectors fueled the return to positive growth in fast reformers. For slow reformers, the main problem in achieving stabilization has been the continued monetization of fiscal and quasi-fiscal deficits, associated with attempts to maintain employment in the old system. Among the policy implications are: 1) stabilization is a priority for the resumption of growth, and this requires extensive liberalization; 2) stabilization is made difficult by output contractions in the early stages of liberalization, by limited external financing, and by very large depreciations of the real exchange rate; and 3) there is no evidence that a slower pace of reform strengthens the fiscal position of slow reformers; their consolidated fiscal and quasi-fiscal deficits are quite high.
Political influence on the central bank is measured here by looking at the probability that a central bank governor will be
replaced shortly after a political change of government. The governor changes about half the time within six months of a nonconstitutional
or other radical change of government—a military coup or a restoration of democracy. The governor is much less likely to change
within six months following a routine change in the head of government—about one-fourth of the time in developing countries
and one-tenth in industrial countries. These indicators vary across countries and correlate statistically with inflation and
its variability and with real growth and real interest rates. Differences in the vulnerability of the central bank to political
instability, in political instability itself, and in central bank turnover in nonpolitical periods seem to be a major part
of the explanation for why developing countries have, on average, higher and more variable inflation than industrial countries
do.
This paper focuses on the management of fiscal deficits and the public debt in the industrial democracies. Given the large deficits in many OECD countries in recent years, and the resulting sharp rise in the public debt, it is important to determine the economic and political forces leading to such large deficits. We find only partial support for the "equilibrium approach to fiscal policy", which assumes that tax rates are set over time in order to minimize the excess burden of taxation. Tax rates do not seem to be smoothed, and budget deficits in many countries in recent years appear to be too large to be explained by appeal to transitory increases in government spending. We suggest that in several countries the slow rate at which the post-'73 fiscal deficits were reduced resulted from the difficulties of political management in coalition governments. There is a clear tendency for larger deficits in countries characterized by a by a short average tenure of government and by the presence of many political parties in a ruling coalition.
This volume contains chapters on a range of topics which include economic methodology in macroeconomics, central bank independence, policy signalling, public policy as second best analysis, the determinants of economic growth, a continuum approach to unemployment policy, and pensions. The volume dispels the notion that these are largely unrelated issues and illustrates the merger process which is taking place between hitherto rather separate economic sub-disciplines. They move the focus of attention and challenge received wisdom.
The recent game-theoretic macroeconomic literature provides a useful tool for analyzing the relationship between political institutions and the macroeconomy. In particular, this paper examines two related issues: the effects of electoral competition on macroeconomic policy and on the economic cycle, and the role of different degrees of independence of the Central Bank as a determinant of monetary policy. The game-theoretic literature in this area has generated several results that are consistent with the empirical evidence. This claim is supported by reviewing the available empirical results and by performing several new tests. In particular, this paper emphasizes the different empirical implications of rational and optimizing politico-economic models in respect to non-rational approaches. Several open issues and new directions of research are also explored in the conclusions.
Politics
Alberto Alesina
Influences from political competition on macroeconomic policy are often thought to be a source of economic fluctuations. Politicians are described as being driven by two, not mutually exclusive, main motivations: they want to be reelected and they harbour political, or ideological, biases. When such theories are confronted with actual cycles in a number of industrial countries, the pattern of inflation, unemployment, output, and budget deficits indicates that partisan policy making is a fairly widespread phenomenon, with more limited evidence that electoral preoccupations result in major fluctuations. The combination of partisanship and electoral cycles may easily result in socially undesirable outcomes. In particular the degree of politico-institutional stability and the independence of the Central Bank have a bearing on macroeconomic outcomes. These observations raise a number of important questions about the design of political institutions.
This paper provides a new indicator for central bank independence (CBI) based on the turnover rate of central bank governors for 82 developing countries over the period 1980–1989. Using this new indicator it is concluded that this proxy for CBI is related to inflation, only if the high inflation countries are included in the sample. The view that both CBI and inflation are caused by effective opposition towards inflation is not supported. Using both the extreme bound analysis and Sala-i-Martin's method we do not find evidence that CBI is robustly related to economic growth.
There has recently been worldwide interest in the question of greater monetary policy autonomy for central banks. According to the December 1991 Treaty on European Economic and Monetary Union (EMU), for example, the European Central Bank is supposed to assume practically unlimited responsibility for monetary policy. The authors set in context the issue of central bank independence and compare different indices of central bank independence.
JEL: E52, E58
Alex Cukierman is well known for his work on central bank behavior. This book brings together a large body of Cukierman's research and integrates it with recent developments in the political economy of monetary policy. Filled with applications and carefully worked out technical detail, it provides a valuable comprehensive analysis of central bank decisions, of the various effects of policy on inflation, and of the feedback from inflationary expectations to policy choices. Cukierman uncovers and analyzes the reasons for positive inflation and rates of monetary expansion. He shows that the money supply, and therefore inflation, are not exogenous. They are influenced by interactions involving distributional considerations, private information, personal motives, and the political environment. This point of view makes it possible to identify the institutional, political, and other features of a country that may be conducive to inflationary environments. Cukierman presents new multidimensional evidence on both legal and actual central bank independence for a sample of up to 70 countries and uses it to investigate the interconnections between the distributions of inflation and of central bank independence. He takes up such issues as why some countries have more independent central banks than others and identifies reasons for the substantial cross country variation in seigniorage. He provides positive explanations for the tendency of central banks, like the US Federal Reserve, to smooth interest rates and to be secretive. Observing that it is likely that the European Economic Community will have a monetary union before the turn of the century, Cukierman applies the techniques of modern political economy to discuss the effect of this change on the commitment to price stability. The book includes simple and advanced materials as well as informal summaries of the major technical results. The introduction contains a modular guide for reading and teaching the material.
In this paper seven hypotheses to explain variation in central bank independence across countries are tested. The predictions based upon the theory that delegation of authority by politicians to the central bank is used as a commitment device are not supported: central bank independence is not higher the larger the employment motivated inflationary bias, the higher political instability or the larger the government debt. Central bank independence is positively related to historical inflation experience and negatively with political instability. We do only find limited support for the view that countries with a universal banking system and countries whose central banks do not regulate financial institutions have more independent central banks.
Following the breakdown of central planning by the early 1990s, transition economies faced varying measures of the need for economic restructuring and stabilisation. This paper examines both the trends in economic performance in eight eastern European countries and the degree of central bank independence (CBI) granted after reforms. The evidence of the paper indicates that both the measures of CBI and the measures of financial market development (FMD) show significant association with macroeconomic variables. Also, the sample exhibits positive association between CBI and measures of FMD.
Sumario: Motives for monetary expansion under perfect information -- Asymmetric information and changing objetives under discretion -- Velocity shocks, politics, signaling, inflation persistence, and accommodation -- Central Bank independence and policy outcomes: theory and evidence
Thesis (Ph. D.)--University of Maryland at College Park, 1997. Thesis research directed by Dept. of Economics. Includes bibliographical references (leaves 154-161).
The second half of 1989, with the fall of the Berlin wall and of a number of communist governments, brought dramatic developments in the process of collapse of the communist system in Eastern Europe and the Soviet Union. The economic transition from the command to the market economy began in earnest in the late 1980s with the Balcerowicz reforms in Poland and the gradual market reforms in Hungary. The end of the Soviet bloc as an integrated economic unit was marked by the historic meeting of the Council for Mutual Economic Assistance (CMEA or Comecon) in Sofia in January 1990 and its decision that trade should be conducted in hard currency and based on world prices. The Soviet Union itself collapsed as an entity following the unsuccessful coup attempt of August 1991 (by the end of that year Gorbachev had resigned as President and the Soviet Union ceased to exist) and in October 1991 the President of Russia, Yeltsin, announced a drastic economic reform programme, under the Gaidar team. Thus the momentous events of these extraordinary two years embodied four inter-related and fundamental elements: the arrival of political democracy; the disintegration of an empire; the collapse1 of an economic bloc; and the launch of the transition. Any attempt to understand the economic aspects of transition in the region must clearly take account of this broader context and the interrelation of these elements.2 It must also take account of the different countries and the differences in the nature and timing of the reform and stabilization programmes.
A public debt theory is constructed in which the Ricardian invariance theorem is valid as a first-order proposition but where the dependence excess burden on the timing of taxation implies an optimal time path of debt issue. A central proposition is that deficits are varied in order to maintain expected constancy in tax rates. This behavior implies a positive effect on debt issue of temporary increases in government spending (as in wartime), a countercyclical response of debt to temporary income movements, and a one-to-one effect of expected inflation on nominal debt growth. Debt issue would be invariant with the outstanding debt-income ratio and, except for a mirror effect, with the level of government spending. Hypotheses are tested on U.S. data since World War I. Results are basically in accord with the theory. It also turns out that a small set of explanatory variables can account for the principal movements in interest-bearing federal debt since the 1920s.
Making the central bank an agency with the mandate and reputation for maintaining price stability is a means by which a government can choose the strength of its commitment to price stability. This article develops four measures of central bank independence and explores their relation with inflation outcomes. An aggregate legal index is developed for four decades in 72 countries. Three indicators of actual independence are developed: the rate of turnover of central bank governors, an index based on a questionnaire answered by specialists in 23 countries, and an aggregation of the legal index and the rate of turnover.
Legal independence is inversely related to inflation in industrial, but not in developing, countries. In developing countries the actual frequency of change of the chief executive officer of the bank is a better proxy for central bank independence. An inflation-based index of overall central bank independence contributes significantly to explaining cross-country variations in the rate of inflation.
This paper documents two empirical relationships that have emerged as the former communist countries have taken steps to transform their economies. First, data from a sample of twelve transition economies suggest that increased central bank independence (CBI) is correlated with lower inflation rates. This CBI-inflation correlation is not well explained by initial economic conditions and persists after controlling for fiscal performance and the overall quality of economic reforms. Second, across a larger set of twenty-five transition economies, there is a strong and robust negative relationship between inflation and subsequent real GDP growth. Inflation's adverse effect on investment appears to be one significant channel through which the relationship between inflation and growth arises. Copyright 1997 by Ohio State University Press.
This note uses information on a sample of sixteen OECD countries to assess the relationship between central bank independence and macroeconomic performance. As previous work suggests, politically controlled central banks are more likely to pursue policies that lead to high and variable inflation. However, the authors find little evidence that political control of central bank policy has any impact on measures of the level or variability of growth, unemployment, or the ex ante real interest rate. Copyright 1993 by Ohio State University Press.
The rationale for the independence of central banks is the so-called 'Rules versus Discretion' debate, which is described in this article. Central bank independence is considered an effective measure against governments from manipulating policy instruments to spur short-term economic growth and employment. Several, recent indices that purport to measure central bank independence are amalgamated and applied to ten European countries, plus New Zealand. Appendices are included on the central bank laws in the eleven countries.
JEL Codes: E58
This paper describes the break-up of the rouble zone after the collapse of the Soviet Union in December 1991 and the opportunities and risks involved in establishing separate currencies in the new republics of the FSU. Fundamental disagreements about the desirable pace of economic reform, together with the need for radical changes in the pattern of economic activity, greatly weakened the case for retention of a single currency. Also, by mid-1993, the reformers in Russia had realised that continued use of the rouble by the republics weakened the authorities' ability to control monetary developments. The introduction of new currencies in countries lacking experience of economic policy making is bound to be a messy and uncertain process. The paper discusses the policy choices involved, in particular the appropriate exchange rate regime and the possible role for a currency board as a way of giving monetary policy credibility at an early stage in the transition. It concludes that bringing the fiscal position under control should be the first aim of policy for these countries. In the absence of bond markets deficits will tend to be money financed and the choice of exchange rate regime, by itself, is probably of second-order importance. The paper concludes with seven case studies, including the Baltic States and the Ukraine. When the paper was written, some republics had inflation rates of 25% a month or more, and there seemed little prospect of a rapid fall. In fact performance has generally been rather better than then seemed likely. The main reasons for this seem to have been the absence of a 'flight-from-money' typical of Latin-American hyperinflation. Fiscal deficits have been kept under reasonable control, probably as a result of external pressure.
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