20
(ii) Θγ is diagonal, which implies that the correlation between the observed legal indices
of central bank independence (y) is only caused by the latent optimal degree
(η).16)
IV.3.The empirical results
On the basis of the restrictions given in the former section, LISREL computes Full
Information Maximum Likelihood estimates of the parameters of the model. Computation
with LISREL renders two different kind of estimations. First, the relationship between the
optimal degree of central bank independence (η, here renamed as OPCBI) and the
explanatory variables (NAIRU_M, WLEFT_M, VPROD_M and SLOPE_M), reflecting the
ultimate determinants of central bank independence, is estimated.17) Second, by estima-
ting this relationship and calculating the optimal degree of central bank independence for
each country (OPCBI), the comparison between the optimal degree and the legal indices
of central bank independence (AL, GMTT, ES and LVAU) can be made. Such a compari-
son is only possible if both the optimal degree and the legal indices are normalized on
their theoretical scale (OPCBI_N, AL_N, GMTT_N and ES_N, respectively).18)
Next to the differences of individual legal indices with the optimal degree, the average
difference (AvDIFF) may be calculated in the following way:
A DIFF [ΑLN] + [GMTT-N] + [ESN] + LVAU [OPCBI N
(4.10)
This average difference is positive, if the average of legal indices exceeds the optimal
degree, and negative, if the optimal degree exceeds the average of legal indices.
A positive average difference indicates that the legal degree of central bank independence
should be decreased, whereas a negative average difference that the legal degree should be
increased in order to bring it closer to the optimal degree based on the ultimate determi-
nants of central bank independence.
Table 4.1 shows the estimation results, with all restrictions imposed in the former section,
for the sample period 1960-1993 (for NAIRU, the sample period 1960-1988).
16) The measurement errors (γ) in equation (4.3) are, thereby, uncorrelated.
17) Because all variables are measured in deviation form their mean and have, thus, zero expectations, the
constant is eliminated from the model.
18) Note that the legal index of Cukierman (LVAU) is already normalized on its theoretical scale, i.e. in
theory its lowest value is 0 and its highest value 1.