Partially Independent Central Banks, Politically Responsive Governments, and Inflation

Abstract

Theories of central bank independence have more exact implications regarding inflation in different political-economic environments than generally understood or empirically examined. They imply that inflation in any given country-time will be a weighted average of what it would be if the central bank completely controlled monetary policy and what it would be if the government completely controlled it, with the degree of central bank independence weighting the former. An equation embodying this theoretical expectation is estimated by constrained least-squares from a time-series cross-section of inflation rates in developed democracies since the Bretton Woods era. The results confirm that the antiinflationary benefit of central bank independence is not constant but rather depends on every variable in the broader politicaleconomic environment to which wholly autonomous central banks and governments would respond differently. Conversely, the inflationary impacts of all such political-economic variables depend on the degree of central bank independence.