Inflation as a Measure of Independence of Central Banks

Abstract

The aim of the article is to study the process of formation of the modern paradigm of independence of central banks, determine the role of inflation in it, outline the criteria for independence and determine the dynamics of legal indicators of autonomy of monetary institutions. It is noted that the impetus for changes in relations between governments and central banks of many industrialized countries was the episodes of high inflation in the 1970s. Awareness of the problem of the time discrepancy between the short-term perspective of political decisions and their long-term impact on the economy provoked institutional changes in the status of monetary institutions. They envisaged the prioritization of central banks’ activities to ensure a consistently low level of inflation and provide independence to achieve it. It is also noted that in countries with economies in transition, the tendency to separate central banks into an independent institution was implemented during the 1990s. The criteria for the independence of central banks are determined by legislation and their charters. These usually include the following: isolation of central bank leadership from political pressure; prohibition to give instructions to central banks in the conduct of monetary policy; a clearly defined purpose of monetary policy; restrictions on lending to government programs and budget deficits. In addition to the formally defined independence, there is also the actual independence of central banks, which is usually outlined through the index of management turnover of monetary institutions and its correlation with the inflation rate. But this does not take into account other (exogenous) factors that affect the inflation rate, which makes the studies less relevant. In addition, the construction of any indices includes an arbitrary weight value of each of them, which reflects the sensitivity of the results obtained depending on their composition. As noted in the study, instead of a static analysis of the indicators of independence of central banks, it is more expedient to determine their modification from the beginning of the formation of the modern paradigm of independence to the present day. The analysis showed that since the beginning of the 1970s, most of the countries studied have changed the rules prohibiting central banks from financing (in any form) the budget deficit. At the same time, obstacles to interference in monetary policy were established. This suggests that the change in these criteria had the greatest impact on the downward trend in the level and volatility of inflation in the period under study.

Keywords

• inflation
• independence of central banks
• monetary policy