A Political Explanation of Variations in Central Bank Independence

Abstract

Although central banks possess a similar function across the industrial democracies, their institutional structures—their levels of independence—differ greatly. My explanation of this variation emphasizes the informational asymmetries of monetary policymaking. Government ministers have informational advantages in the policy process, potentially creating conflicts with backbench legislators and, in a multiparty government, coalition partners. An independent central bank can help alleviate these conflicts. Politicians will choose an independent bank (1) if government ministers, party legislators, and coalition partners have different monetary policy incentives and (2) if government ministers fear that party legislators and coalition partners will withdraw their support over a policy dispute. I statistically test the argument against the cross-national variation of central bank institutions. I also use the theoretical framework to examine episodes of institutional choice and reform in Germany, Britain, and Italy.