The ultimate determinants of central bank independence

provided by Research Papers in Economics

THE ULTIMATE DETERMINANTS OF

CENTRAL BANK INDEPENDENCE

by

Sylvester Eijffinger and Eric Schaling

Department of Economics and CentER for Economic Research,
Tilburg University, P.O. Box 90153, 5000 LE Tilburg, The Netherlands

Paper Prepared for the CentER Conference
‘Positive Political Economy: Theory and Evidence’, January 23-24, 1995,
Tilburg, The Netherlands

Abstract

Using a graphical method, a new way of determining the optimal degree of central bank
conservativeness is developed in this paper. Unlike Lohmann (1992) and Rogoff (1985),
we are able to express the upper and lower bounds of the interval containing the optimal
degree of conservativeness in terms of the structural parameters of the model.

Next, we show that optimal central bank independence is higher, the higher the natural
rate of unemployment, the greater the benefits of unanticipated inflation, the less inflation-
averse society, and the smaller the variance of productivity shocks. These propositions are
tested for nineteen industrial countries (Australia, Austria, Belgium, Canada, Denmark,
Finland, France, Germany, Ireland, Italy, Japan, New Zealand, the Netherlands, Norway,
Spain, Sweden, Switzerland, the United Kingdom and the United States) for the post-
Bretton-Woods period (1960-1993). In testing the model we employ a latent variables
method (LISREL) in order to distinguish between actual and optimal monetary regimes.

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