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Price Stability and Central Bank Independence: Discipline, Credibility, and Democratic Institutions

Published online by Cambridge University Press:  17 December 2014

Cristina Bodea  and
Raymond Hicks
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Abstract

Despite mixed empirical evidence, in the past two decades central bank independence (CBI) has been on the rise under the assumption that it ensures price stability. Using an encompassing theoretical approach and new yearly data for de jure CBI (seventy-eight countries, 1973–2008), we reexamine this relationship, distinguishing the role of printing less money (discipline) from the public's beliefs about the central bank's likely actions (credibility). Democracies differ from dictatorships in the likelihood of political interference and changes to the law because of the presence of political opposition and the freedom to expose government actions. CBI in democracies should be directly reflected in lower money supply growth. Besides being more disciplinarian, it also ensures a more robust money demand by reducing inflation expectations and, therefore, inflation. Empirical results are robust and support a discipline effect conditioned by political institutions, as well as a credibility effect.

Type
Research Article
Information
International Organization , Volume 69 , Issue 1 , Winter 2015 , pp. 35 - 61
Copyright
Copyright © The IO Foundation 2015 

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Footnotes

An earlier version of this research note was presented at IPES 2012. We thank Lawrence Broz, Meredith Wilf, and Joanne Gowa for helpful comments. Comments from two anonymous reviewers and the IO editor helped bring the paper to its final form. Errors remain ours.

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