Central Bank Behavior and Statutory Independence

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This paper integrates the Taylor reaction function literature with the literature on central bank independence (CBI). The central bank’s policy reaction function describes its behaviors, which measures the practical CBI, as opposed to the legal CBI measured by CBI indices. By analyzing the relationship between various legal CBI indices and the central banks’ reactions to inflation for 18 OECD countries, we find that the difference of behaviors among central banks is consistent with the economic measure of independence, which measures how easy it is for the government to finance its deficits by direct access to credit from the central bank.