Decentralization and Inflation: Commitment, Collective Action, or Continuity?

Abstract

Do political and fiscal decentralization make it easier or harder to control inflation? Statistical analysis of average annual inflation rates in a panel of 87 countries in the 1970s and 1980s found no clear relationship between decentralization and the level of inflation. Political decentralization, however, does appear to reduce change in countries' relative inflation rates over time. By creating additional veto players, federal structure may “lock in” existing patterns of monetary policy—whether inflationary or strict. Among the (mostly developed) countries that started with low inflation, inflation tended to increase more slowly in federations than in unitary states. Among the (mostly developing) countries that started with high inflation, inflation tended to increase faster in the federations. There is evidence that political decentralization locks in a country's degree of practical central bank independence—whether high or low—and the relative hardness or softness of budget constraints on subnational governments.