Central bank independence and transparency: Not just cheap talk (Part 1)

Christopher Crowe, Ellen E. Meade 27 July 2008

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In recent days, French President Nicolas Sarkozy has called for changes that would increase the accountability of the European Central Bank, including the publication of meeting minutes for its Governing Council.1 This and other types of accountability measures are generally seen as the counterpart to high levels of central bank independence. Without question, independence has risen over the past 10 to 15 years as newly established central banks – the European Central Bank as well as those in Central and Eastern Europe – and a number of older central banks have redrafted their laws. With these reforms has come steady progress toward greater institutional autonomy, accountability, and transparency in a large number of industrial and developing countries.

In an attempt to quantify some of these developments, we have followed the well-recognised methodology of Cukierman, Webb, and Neyapti (1992) and put together new indices of central bank independence and monetary policy transparency (Crowe and Meade, 2007 and 2008). For the measurement of both independence and transparency, we have chosen our methodology and data to make it easier to assess not only the current state of play but also the evolution of governance practices over time.

Measurement of central bank independence has generally focused on a set of legal characteristics obtained from an institution’s statutes. Broadly speaking, these legal characteristics relate to four different aspects of a central bank’s independence from government.

  • Independence is greater when the central bank’s officials are insulated from political pressure by secure tenure and independent appointment.
  • The central bank enjoys greater freedom when the government cannot participate in or overturn its policy decisions and,
  • When the central bank’s legal mandate specifies some price stability goal (whether as a unitary objective or as one of several objectives).
  • Financial independence of the central bank relies upon restrictions that limit lending to the government.

The methodology is based on Cukierman, Webb, and Neyapti (1992, henceforth CWN), who measured independence in 72 countries using 16 different legal characteristics from central bank statutes in the 1980s. We have used their method to produce new measures for 96 countries using a database of central bank laws held by the IMF that is current through 2003.

Our findings on central bank independence

Today’s central banks are far more independent than they were in the 1980s. Eighty-five percent of the central banks in our sample received a score above 0.4 (see table), compared with only 38%in the CWN sample. Average independence has risen from slightly more than 0.3 in the CWN sample to above 0.6 in ours.

Among advanced economies, the European Central Bank and Sweden’s Riksbank ranked the most independent with scores of 0.83 and 0.85 (out of a possible 1.0), respectively, according to our updated measure. These scores are 2 to 2½ times larger than those recorded in the CWN study for the respective countries. For instance, the European Central Bank, whose statutes were specified in the Maastricht Treaty, has much greater independence today than its members’ national central banks had in the 1980s with respect to the determination of monetary policy and lending to the government. Interestingly, the Federal Reserve’s score (0.48) is unchanged today from what it was in the 1980s because its central bank law has not been amended. While the Fed’s independence score in the CWN study was significantly above the mean for the industrial countries in their sample, it ranks significantly below the mean for the advanced economies in ours.

Table 1 Frequency distribution of central bank independence, all countries

  1980-89* 2003
0.2 < x ≤ 0.4 39 13
0.4 < x ≤ 0.6 24 34
0.6 < x ≤ 0.8 3 20
Total 72 96

*From CWN.

Central banks in emerging market and developing economies have seen an even more impressive shift towards independence over the past two decades than their industrial-country counterparts. Of the 15 central banks that we rate as highly independent (with scores above 0.8), two-thirds are located in eastern European countries. See Table 3 at the end for a more complete list of countries and scores and here for the raw data.

But is greater independence necessarily better?

When the central bank is granted authority over monetary policy and given independence, monetary policy is moved to the sidelines of the democratic process. In some cases, as President Sarkozy has suggested is the case with the European Central Bank, this gap in democracy can pose a problem.

Generally speaking, countries have addressed the need for independence with the requirement for institutional accountability in two ways: by limiting the remit of the central bank and by requiring it to be accountable to the public. With regard to the latter, most central banks are required to report on and explain their actions to the legislature and to the broader public – the European Central Bank already does this. Thus, the central bank’s transparency is an important by-product of its independence.

Assessing central bank transparency

In order to assess transparency, we broadly followed the methodology of Eijffinger and Geraats (2006) in constructing a measure for 37 countries for the late 1990s and 2006. The earlier measure is based on the results of a survey of central banks carried out by the Bank of England in 1998, while the updated measure is based upon our reading of central bank transparency practices from information on their websites and in their publications.

Table 2. Mean transparency scores

  Number 1998 2006
All Countries 37 0.56 0.61
Emerging Market and Developing 13 0.55 0.54
Eurozone Members 12 0.45 0.60***

Note: *** indicates difference in mean is statistically significant at the 99% confidence level.

Eijffinger and Geraats measured transparency in terms of five components intended to capture political, economic, procedural, policy, and operational aspects. Political transparency pertains to the clarity of the central bank’s legal mandate. Economic transparency refers to the publication of the economic data, models, and forecasts used by the central bank to arrive at its policy decisions. Procedural transparency is the communication of the explicit policy strategy as well as information on the decision-making process.

Policy transparency includes the timely announcement and explanation of policy actions, and some indication of likely future actions. The final component, operational transparency, is the discussion of economic disturbances and policy errors that are likely to affect the transmission of policy.

Conclusion

We find that overall levels of transparency have not increased significantly since the late 1990s (see Table 2). However, this overall average masks some important changes for different categories of central banks. For advanced economies, there was a statistically significant rise in transparency, while emerging market and developing economies experienced essentially no change. And, President Sarkozy should be happy to note, the European Central Bank is markedly more transparent than the national central banks of the twelve Eurozone-member countries were in 1998 (although ECB transparency remains well below the average level of inflation-targeting central banks).

In a subsequent Vox column, we will discuss the implications of central bank independence and transparency for inflation and inflation forecasting.

We hope that our data (available for download here) will be widely used to test other hypotheses in the area of central bank governance.

Table 3 Figures on selected central bank independence and transparency

 

Independence 2003

Transparency 1998

Transparency 2006

Albania
0.71
0.30
 
Austria
0.83
0.20
0.60
Belgium
0.83
0.30
0.60
Bulgaria
0.83
0.30
 
Croatia
0.88
0.40
 
Cyprus
 
0.10
 
Czech Rep.
0.80
0.80
0.70
ECCB
0.48
 
 
Finland
0.83
0.60
0.60
France
0.83
0.40
0.60
Germany
0.83
0.35
0.60
Hungary
0.82
0.50
0.90
Iceland
0.73
0.65
0.70
Ireland
0.83
0.65
0.60
Italy
0.83
0.60
0.60
Latvia
0.90
0.40
 
Lithuania
0.86
0.60
 
Luxembourg
0.83
0.30
0.60
Malta
0.42
0.55
 
Netherlands
0.83
0.70
0.60
Norway
0.32
0.60
0.70
Poland
0.88
0.70
0.90
Romania
0.59
0.55
0.60
UK
0.31
0.90
1.00
Brazil
0.46
 
0.65
China
0.60
0.65
0.15
India
0.28
0.50
0.15
Japan
0.38
 
0.85
USA
0.48
0.85
0.80

Source: Crowe and Meade, 2008.

References

Crowe, C., Meade, E. E., 2008. Central Bank Independence and Transparency: Evolution and Effectiveness. European Journal of Political Economy, forthcoming.
Crowe, C., Meade, E.E., 2007. Evolution of Central Bank Governance around the World. Journal of Economic Perspectives 21, 69--90.
Cukierman, A., Webb, S.B., Neyapti, B., 1992. Measuring the Independence of Central Banks and Its Effect on Policy Outcomes. The World Bank Economic Review 6, 353--398.
Eijffinger, S., Geraats, P., 2006. How Transparent Are Central Banks? European Journal of Political Economy 22, 1-21.


1 The views expressed herein are those of the authors and should not be attributed to the IMF, its Executive Board, or its management.

 

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Topics:  EU institutions

Tags:  ECB, transparency, Central Banks

Economist in the Strategic Issues Division of the Research Department, IMF

Associate Professor in the Department of Economics, American University