independence. For instance, no explanation is offered for the very high independence of
the Bundesbank. It has often been pointed out that this independence may be explained by
Germany’s underlying aversion to inflation associated with its experience of hyper-
inflation in the 1920s.3)
This brings us to a key issue in the political economy of central banking: the relation
between institutional design and individual and collective preferences. Here the question to
be dealt with is the normative issue of how independent a central bank should be, i.e. the
optimal degree of central bank independence.
An important study in this field is Cukierman (1994). Building on the seminal paper of
Lohmann (1992), he wants to identify the economic and political factors that induce
politicians to delegate more or less authority to the central bank. His theory predicts that
central bank independence will be higher the larger the employment-motivated inflationary
bias, the higher political instability and the larger the government debt.
These predictions were tested and, subsequently, rejected by De Haan and Van ’t Hag
(1994) using regression analysis (OLS method). In testing Cukierman’s model, they
employ measures of central bank independence that in - Rogoff’s (1985) terminology -
reflect the strength of the ‘conservative bias’ of the central bank as embodied in the law.
In Cukierman’s model, following Lohmann (1992), central bank independence is defined
as the cost of overriding the central bank, rather than as the degree of conservativeness.
Cukierman’s (1994) theory also generates propositions about optimal regimes, whilst the
legal measures describe actual monetary regimes.
In this paper we try to overcome these pitfalls. Building on the Rogoff (1985) model, we
identify central bank independence as the degree of conservativeness rather than the
political cost of overriding the central bank. Using a graphical method, we develop a new
way of determining the optimal degree of conservativeness. As in Lohmann (1992), this
degree depends on the balance between credibility and flexibility. However, unlike Rogoff
and Lohmann, we are able to express the upper and lower bounds of the interval contai-
ning the optimal degree of conservativeness in terms of the structural parameters of the
model.
Furthermore, we derive several propositions concerning the relation between economic
and political factors and the optimal degree of central bank independence. We show that
optimal central bank independence is higher, the higher the natural rate of unemployment,
the greater the benefits of unanticipated inflation (the slope of the Phillips curve), 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
3) See for instance Issing (1993).