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Central Bank Independence and Inflation: Schumpeterian Theory and Evidence

Author

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  • Qichun He

    (Central University of Finance and Economics)

  • Heng-fu Zou

    (Central University of Finance and Economics)

Abstract

We first use a monetary Schumpeterian model to investigate how central bank independence (CBI) affects inflation. It is found that we can predict a mixed, non-monotonic relationship between CBI and inflation. Under inelastic labor supply, when the seigniorage is mainly used to finance entrepreneurs, a condition that is more likely in developed countries, CBI has a positive effect on inflation; in contrast, when the seigniorage is mainly used to finance non-productive government spending, a situation more commonly found in developing countries, CBI has a negative effect or no effect on inflation. As an empirical test, we build panel data for 68 countries during 1998–2010 and find that the effect of CBI on inflation is positive and significant in developed countries, and it is insignificant (at the 5% level) in developing countries in both system generalized method of moments (GMM) and instrumental variable (IV) estimations. Our results remain robust to the consideration of financial crises, financial development, and other factors affecting inflation. Our empirical findings provide support for our theory.

Suggested Citation

  • Qichun He & Heng-fu Zou, 2024. "Central Bank Independence and Inflation: Schumpeterian Theory and Evidence," Annals of Economics and Finance, Society for AEF, vol. 25(2), pages 463-500, November.
    • Handle: RePEc:cuf:journl:y:2024:v:25:i:2:hezou
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    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Systems; Standards; Regimes; Government and the Monetary System
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • O42 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - Monetary Growth Models

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