Impact of trilemma indicators on macroeconomic policy: Does central bank independence matter?

As countries have become increasingly integrated in their capital accounts and moved away from fixed exchange rates, pressures mount on central banks to maintain an independent monetary policy. Amidst the constraints imposed by this monetary policy trilemma, the ability of central banks to take decisions independent of domestic political pressures becomes crucial. The literature suggests that the trilemma choices when opted carefully render the independence of central banks unnecessary in stabilizing macroeconomic outcome. For a sample of 42 high and middle income countries analyzed over a period of 30 years ranging from 1982 till 2011, this paper shows that while an efficient trilemma policy choice can help lower inflation and improve growth, the independence of central banks from the domestic political pressure, as measured in terms of the actual number of turnover of central bank governors, still matters. This is especially true of middle income countries. A less independent central bank can worsen the outcome derived from an effective trilemma policy choice. In addition, this paper shows that the institutional changes such as Inflation Targeting (IT) helps lower inflation without depending upon the level of Central Bank Independence (CBI) in a country as is suggested in the literature while the occurrence of general elections (ELEC) in any country exacerbates the macroeconomic outcome if a country grants lower autonomy to its central bankers.