I. INTRODUCTION1)
Recently, in many countries both political and monetary authorities have shown an
increasing interest in the objective of monetary stability and the position of the central
bank. As pointed out by Persson and Tabellini (1993) recent policy reform, as well as
historical experience, suggests two different routes to price stability.
The first way is the legislative approach, namely to create by law a very independent
central bank with an unequivocal mandate to focus on price stability. Interest in this
approach is motivated by the success of the Deutsche Bundesbank in maintaining one of
the lowest rates of inflation for several decades. Moreover, the accepted statute of the
European Central Bank is strongly influenced by the law governing the Bundesbank.
Moreover, France and Spain reformed their central bank laws that made the Banque de
France and the Banco de Espafia more independent of government. Furthermore, countries
in Central and Eastern Europe, such as the Czech Republic, Hungary and Poland,
increased the legal independence of their central banks. Finally, in Latin America there are
also tendencies toward granting more independence to the central banks in countries like
Argentina, Chile, Mexico and Venezuela. Academic contributions in this area are Rogoff
(1985), Neumann (1991) and Lohmann (1992).
The second way is the targeting or contracting approach, namely to let the political
principal of the central bank impose an explicit inflation target for monetary policy, and
make the central bank governor explicitly accountable for his success in meeting this
target. Recently, New Zealand, Canada, and the United Kingdom have made some
progress on this route. Along these lines New Zealand enacted legislation that increased
the independence of its Reserve Bank, whereas in the United Kingdom there is now
alively discussion of the desirability of making the Bank of England more independent.2)
Important theoretical work on this approach is done by Walsh (1993) and Persson and
Tabellini (1993).
Empirical work on the legislative approach [Alesina (1988, 1989), Grilli, Masciandaro
and Tabellini (1991), Cukierman (1992), Eijffinger and Schaling (1992, 1993a, 1993b), De
Haan and Sturm (1992), Alesina and Summers (1993)] has focused on the quantification
of independence using a number of legal attributes from central bank laws. These studies
focus on the positive issue of the relation between monetary regimes and economic
performance. Broadly speaking, the conclusion is that the more independent the central
bank, the lower the inflation rate, whilst the rate of output growth is unaffected.
However, this literature does not explain the observed differences in central bank
1) The authors owe a debt of gratitude to Marco Hoeberichts for his empirical support. They are also
grateful to Marno Verbeek for his valuable suggestions with respect to the latent variables method.
2)
For a recent discussion about the independence of the Bank of England and the associated inflation
targeting framework see Centre for Economic Policy Research (1993).