Central Bank Independence, Inflation, and Growth in Transition Economies

Abstract

In 1his paper, we document two empirical relationships iliat have emerged as ilie former communist countries have taken steps to transform their economies from command systems to market-based systems.First, increased central bank independence has tended to improve inflation performan<;e.Second, high inflation has adversely affected real activity.More specifically, in the first sec;tion of iliis paper, we develop indices of central bank independence (CBI) for twelve transition economies and examine the relationship between CBI and inflation performance across iliese countries.Statistical evidence suggests iliat the transition economies with more independent central banks have achieved lower inflation than their counterparts.The second section of this paper studies ilie relationship between inflation and growth in twenty-six transition economies.We present econometric evidence indicating iliat reducing inflation helps stabilize economic activity, following ilie sharp output declines iliat occur during ilie initial stages of transition.The paper conc1udes iliat establishing an independent central bank is a concrete institutional reform iliat may re:duce inflation and thus facilitate economic grow1h.