Central Bank Reform, Liberalization and Inflation in Transition Economies: An International Perspective

This paper develops extensive new data on the legal independence of new central banks in 26 former socialist economies (FSE).This data is constructed using the codification system for measuring legal independence developed in Cukierman, Webb and Neyapti (1992) and in chapter 19 of Cukierman (1992).This makes it comparable with earlier data on central bank independence (CBI) in the industrial democracies and in, non FSE, developing countries and permits experimentation with alternative indices of CBI like those reviewed in Eijffinger and van Keulen (1995).The new indices of independence indicate that central bank (CB) reform in the FSE during the nineties has been quite ambitious.In spite of the large price shocks induced by the transformation from plan to market, reformers in those countries chose to create central banks with levels of legal independence that are substantially higher, on average, than those of developed economies during the eighties.Based on data from 1989 through 1998 the evidence in the paper suggests that CBI is unrelated to inflation during the early stages of liberalization.But for sufficiently high and sustained levels of liberalization, and controlling for variables like price decontrols and wars, legal CBI and inflation are significantly and negatively related.These findings are consistent with the view that legal CBI, no matter how high, cannot contain the powerful inflationary impact of wide scale liberalization of formerly controlled prices.But once the process of liberalization has gathered sufficient momentum legal independence becomes effective in slowing inflation down and the cumulative liberalization index developed by de Melo et. al.(1996) becomes relatively less important.The paper also presents evidence on factors that affect the level of CBI and examines the relation between inflation and CBI within a broader sample composed of the transition and of the developed economies.