Dynamic Central Bank Independence indices and Infation : an empirical exploration

Dynamic Central Bank Independence indices andInflation : an empirical exploration

M. Arnone 1 D. Romelli 2 3

1Centre for Macroeconomics & Finance Research (CeMaFiR), Italy

2THEMA–Universite de Cergy Pontoise, France

3ESSEC Business School, France

FinLawMetrics 2012Universita Commerciale Luigi Bocconi

Arnone, Romelli Dynamic CBI indices and Inflation

MotivationCBI indices, reforms and Inflation

Panel Data AnalysisConclusions and future research

Table of contents

1 MotivationCBI-Inflation PuzzleOpen questions

2 Central Bank Independence indices, reforms and InflationCBI indicesCBI Indices dynamicsUnit root testsRobustness of the break dates

3 Panel Data AnalysisOLS Fixed Effects regression for inflation and CBIPCSE regression for inflation and CBIRobustness checks

4 Conclusions and future researchConclusionsFuture research




CBI-Inflation PuzzleOpen questions

The creation of CBI indices

Rogoff (1985)

Delegate the monetary policy to a central banker that places “toolarge” a weight on inflation rate stabilization

How to measure the credibility of a Central Bank?

De jure CBI indices1 Grilli, Masciandaro, and Tabellini [GMT] (1991)2 Cukierman, Webb, and Neyapti [CWN] (1992)

De facto CBI indices1 Cukierman, Webb, and Neyapti [TOR] (1992)





The creation of CBI indices

Rogoff (1985)

Delegate the monetary policy to a central banker that places “toolarge” a weight on inflation rate stabilization

How to measure the credibility of a Central Bank?

De jure CBI indices1 Grilli, Masciandaro, and Tabellini [GMT] (1991)2 Cukierman, Webb, and Neyapti [CWN] (1992)

De facto CBI indices1 Cukierman, Webb, and Neyapti [TOR] (1992)





Cross-Country Analysis

Limitation: No explicit evaluation of central bank law reforms onthe inflation rate dynamics

Panel data Analysis (time varying indices)

1 No CBI-Inflation relationship:Cukierman, Miller, and Neyapti (2002) [26 FSE]

2 Negative CBI-Inflation relationship:Jacome and Vazquez (2008) [24 LAC countries]Arnone et al. (2009) [15 Developing countries]

3 Unclear CBI-Inflation relationship:Acemoglu et al. (2008) [52 countries]





The impact of a central bank law reforms

Open questions

1 Did legislative reforms have a real impact on the inflation ratedynamics of major OECD countries?

2 How to evaluate the impact of central bank law reforms?

Time series analysis of the inflation rate dynamics

3 How to evaluate the relationship between CBI and inflation?

Panel data analysis





The impact of a central bank law reforms

Open questions

1 Did legislative reforms have a real impact on the inflation ratedynamics of major OECD countries?

2 How to evaluate the impact of central bank law reforms?

Time series analysis of the inflation rate dynamics

3 How to evaluate the relationship between CBI and inflation?

Panel data analysis

Our results

Reforms that highly modify the level of CBI represent a structuralbreak for the inflation rate dynamics.

Economic independence index and the overall CBI present anegative and statistically significant relation with inflation.

Importance to compute dynamic CBI indexes.




CBI indicesCBI Indices dynamicsUnit root testsRobustness of the break dates

CBI indices selection

Which GMT index?

Grilli, Masciandaro, and Tabellini (1991) [GMT]

Political independence index

Capacity of the monetary authorities to independently achieve the finalgoals of their policy

Economic independence index

Independence of the central bank in choosing its instruments of monetarypolicy

Which Countries?

10 Advanced economies: Australia, Canada, France, Germany, Italy,Japan, New Zealand, Switzerland, United Kingdom, United States.






Which GMT index?






Which Countries?







Which GMT index?






Which Countries?






CBI indices characteristics

GMT Coding

Political Independence(1) Is the Governor not appointed by government? 1: Yes 0: NO(2) Is the Governor appointed for more than 5 years? 1: Yes 0: NO(3) Are all the Board members not appointed by government? 1: Yes 0: NO(4) Are all the Board members appointed for more than 5 years? 1: Yes 0: NO(5) Is there no mandatory participation of government representative in the Board? 1: Yes 0: NO(6) Is the government approval not required for monetary policy formulation? 1: Yes 0: NO(7) Is there a statutory requirement for the central bank to pursue monetary stability amongst its goals? 1: Yes 0: NO(8) Are there legal provisions that strengthen the central bank’s position in conflicts with the Government? 1: Yes 0: NO

Economic Independence(1) Is direct credit not automatically extended to the government? 1: Yes 0: NO(2) Is direct credit provided at market interest rates? 1: Yes 0: NO(3) Is direct credit explicitly temporary? 1: Yes 0: NO(4) Is direct credit subject to limitations on amount? 1: Yes 0: NO(5) Does the central bank participate in the primary market for public debt securities? 1: Yes 0: NO(6) Are discount rate set by the Centtral Bank? 1: Yes 0: NO(7) Is banking supervision not entrusted to the central bank, or not entrusted to the central bank alone 1: Yes 0: NO





GMT CBI indexes changes (1972-2010)

Country ∆ Pol. Indep. (Max 8 pts.) ∆ Econ. Indep. (Max 8 pts.) Year

Australia 0 +2 1998Canada 0 0France +3 +2 1993

+3 0 1998Germany +2 -1 1998Italy +3 +4 1993

+1 0 1998Japan 0 +1 2000New Zealand +2 +2 1989Switzerland +2 +1 2003United Kingdom +2 +3 1998United States 0 0





Unit root tests with structural breaks on the inflation rate (1972-2010)

ZA k PV k CMR k

Australia -7.538** 3 -3.913** 4 -4.413 4(1996:4) (1989:3)** (1977:1)** ; (1990:2)**

Canada -4.676* 1 -3.058 4 -5.559** 6(1994:2) (1983:3)** (1983:3)** ; (1992:2)**

France -4.404 1 -4.824** 6 -5.943** 6(1993:3) (1986:3)** (1984:4)** ; (1993:1)**

Germany -3.907 3 -3.378 1 -4.555 5(1986:1) (1984:4)** (1984:4)** ; (1991:3)

Italy -5.228** 1 -2.585 9 -4.717 5(1997:1) (1985:2)** (1985:1)** ; (1996:4)**

Japan -9.647** 3 -3.519 12 -0.435 4(1983:1) (1978:3)** (1974:1)** ; (1998:1)**

New Zealand -4.555** 1 -2.983 12 -3.468 12(1999:1) (1989:1)** (1986:4)** ; (1989:3)**

Switzerland -4.379 3 -2.334 9 -3.505 6(1978:3) (1976:3)** (1974:1)** ; (1995:1)**

United Kingdom -4.369 3 -2.482 12 -3.593 10(1986:3) (1983:3)** (1976:4)** ; (1983:1)**

United States -5.175** 3 -1.879 12 -2.099 12(1986:4) (1983:2)** (1979:2)** ; (1982:2)**

**/* Significant at 5%/10%;

Note: ZA = Zivot and Andrews; PV = Perron and Vogelsang; CMR = Clemente, Montanes, and Reyes;





Figure: Inflation rate dynamics and structural breaks (1972-2010)

France (1977;1984;1993)

Time

Infla

tion

rate

1980 1990 2000 2010

05

10

New Zealand (1989)

Time

Infla

tion

rate

1980 1990 2000 2010

05

1015





Figure: Inflation rate dynamics and structural breaks (1972-2010)

Italy (1984;1996)

Time

Infla

tion

rate

1980 1990 2000 2010

05

1015

20




OLS Fixed Effects regression for inflation and CBIPCSE regression for inflation and CBIRobustness checks

πc,t = απc,t−1 + γEc,t + δPc,t + ρc + ϕt + εc,t

Table: OLS Fixed Effects regression for inflation and CBI (1972-2010)

Full sample Restricted sample(1) (2) (3) (4)

Inflationt−1 0.643*** 0.794*** 0.653*** 0.782***(0.04) (0.02) (0.04) (0.02)

Economic indep. -3.324*** -2.925** -3.320*** -3.112**(0.77) (1.06) (0.75) (1.14)

Political indep. 0.059 -0.858 -0.059 -0.912(0.39) (0.61) (0.40) (0.65)

Constant 7.681*** 3.773*** 7.709*** 4.014***(0.81) (0.94) (0.94) (1.03)

Country Fixed Effects Yes Yes Yes YesYear Fixed Effects Yes Yes

R2 0.891 0.778 0.892 0.786Obs. 380 380 304 304

***/** Significant at 1%/5%.Note: Robust standard errors, adjusted for clustering by country, in parentheses.





πc,t = απc,t−1 + γEc,t + δPc,t + ρc + ϕt + εc,t

Table: OLS Fixed Effects regression for inflation and CBI (1972-2010)

Full sample Restricted sample(1) (2) (3) (4)

Inflationt−1 0.643*** 0.794*** 0.653*** 0.782***(0.04) (0.02) (0.04) (0.02)

Economic indep. -3.324*** -2.925** -3.320*** -3.112**(0.77) (1.06) (0.75) (1.14)

Political indep. 0.059 -0.858 -0.059 -0.912(0.39) (0.61) (0.40) (0.65)

Constant 7.681*** 3.773*** 7.709*** 4.014***(0.81) (0.94) (0.94) (1.03)

Country Fixed Effects Yes Yes Yes YesYear Fixed Effects Yes Yes

R2 0.891 0.778 0.892 0.786Obs. 380 380 304 304

***/** Significant at 1%/5%.Note: Robust standard errors, adjusted for clustering by country, in parentheses.





Time Series Cross-Section Analysis

πc,t = βxc,t + εc,t

πc,t : inflation rate in country c, at time t,

xc,t : vector of independent variables.





Table: PCSE for inflation and CBI (1972-2010) [Full sample]

Standardized CBI indices Dummy CBI(1) (2) (3) (4) (5) (6)

Economic indep. -3.983*** -2.192*** -4.195*** -0.197 -0.152 -0.168(1.17) (0.54) (0.86) (0.86) (0.33) (0.54)

Political indep. -0.753 -0.571 -0.566 0.030 -0.023 0.572(0.83) (0.41) (0.89) (0.81) (0.32) (0.53)

Openness to trade 0.004 0.009 -0.004 -0.006 0.004 -0.017*(0.02) (0.01) (0.01) (0.02) (0.01) (0.01)

Output Gap 0.110** 0.067** 0.018 0.114 0.064** 0.034(0.06) (0.03) (0.04) (0.06) (0.03) (0.04)

Inflation Targeting 0.229 -0.199 0.384 0.231 -0.158 0.363(0.62) (0.32) (0.48) (0.62) (0.30) (0.49)

Money Market Rate 0.436*** 0.483***(0.03) (0.03)

Real Interest Rate -0.464*** -0.461***(0.04) (0.04)

Constant 8.033*** 4.874*** 9.757*** 5.346*** 3.081*** 6.930***(1.02) (0.51) (0.65) (0.54) (0.29) (0.37)

Year Dymmy Yes Yes Yes Yes Yes YesAR(1) Yes Yes Yes Yes Yes Yes

R2 0.559 0.722 0.719 0.533 0.723 0.700Obs. 380 364 354 380 364 354

***/**/* Significant at 1%/5%/10%.Note: Panel corrected standard error (PCSE), in parentheses.





Table: PCSE for inflation and CBI (1972-2010) [CB with law reforms]


Economic indep. -4.432*** -2.210*** -5.105*** -0.156 -0.032 -0.200(1.31) (0.56) (0.95) (0.89) (0.35) (0.60)

Political indep. -0.893 -0.871* -0.547 0.112 -0.384 0.774(1.01) (0.47) (1.02) (0.83) (0.36) (0.57)

Openness to trade -0.012 -0.020** -0.002 -0.007 0.011 -0.026*(0.03) (0.01) (0.01) (0.03) (0.01) (0.01)

Output Gap 0.108* 0.125*** 0.044 0.128* 0.144*** 0.067(0.06) (0.04) (0.05) (0.07) (0.04) (0.05)

Inflation Targeting 0.109 -0.344 -0.239 0.090 -0.285 0.124(0.76) (0.34) (0.59) (0.76) (0.33) (0.59)



Constant 8.326*** 4.836*** 10.257*** 5.805*** 3.07*** 7.32***(1.07) (0.53) (0.65) (0.70) (0.32) (0.46)


R2 0.554 0.744 0.720 0.532 0.751 0.720Obs. 304 291 283 304 291 283






Table: PCSE for inflation and overall CBI (1972-2010) [Full sample]


Overall CBI -4.269*** -2.410*** -4.403*** -0.254 -0.386 -0.199(1.48) (0.68) (0.99) (0.58) (0.27) (0.35)

Openness to trade 0.009 0.011 0.003 -0.006 0.003 -0.013(0.02) (0.01) (0.01) (0.02) (0.01) (0.01)

Output Gap 0.108* 0.061** 0.028 0.114** 0.063** 0.035(0.06) (0.03) (0.04) (0.06) (0.03) (0.04)




Constant 7.154*** 4.35*** 8.856*** 5.324*** 3.11*** 6.838***(0.873) (0.43) (0.61) (0.873) (0.28) (0.36)


R2 0.555 0.719 0.713 0.534 0.722 0.700Obs. 380 364 354 380 364 354






Table: PCSE for inflation and overall CBI (1972-2010) [CB with lawreforms]


Overall CBI -4.630*** -2.732*** -4.990*** -0.192 -0.422 -0.322(1.73) (0.74) (1.18) (0.70) (0.34) (0.42)

Openness to trade 0.022 0.024*** 0.013 -0.006 0.007 -0.018(0.03) (0.01) (0.01) (0.03) (0.01) (0.01)

Output Gap 0.104 0.123*** 0.048 0.128* 0.141*** 0.069(0.06) (0.04) (0.05) (0.07) (0.04) (0.05)




Constant 7.220*** 4.318*** 8.887*** 5.763*** 3.168*** 7.122***(0.88) (0.41) (0.63) (0.66) (0.29) (0.43)


R2 0.542 0.743 0.711 0.532 0.748 0.696Obs. 304 291 283 304 291 283





ConclusionsFuture research

Conclusions

Reforms that highly modify the level of CBI represent astructural break for the inflation rate dynamics.

Economic independence index present a negative andstatistically significant relation with inflation.

Importance to compute dynamic CBI indexes.





CBI indices implementation

1 Expand the sample of analyzed countriesData availability:

175 CBs [196 countries]

2 Extension of the GMT CBI index (e.g. profits allocation,central bank financial independence)





Thank YOU!


Dynamic Central Bank Independence indices and Infation : an empirical exploration

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