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Price Stability and Central Bank Independence: Discipline, Credibility, and Democratic Institutions

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  • Bodea, Cristina
  • Hicks, Raymond

Abstract

Despite mixed empirical evidence, in the past two decades central bank independence (CBI) has been on the rise under the assumption that it ensures price stability. Using an encompassing theoretical approach and new yearly data for de jure CBI (seventy-eight countries, 1973–2008), we reexamine this relationship, distinguishing the role of printing less money (discipline) from the public's beliefs about the central bank's likely actions (credibility). Democracies differ from dictatorships in the likelihood of political interference and changes to the law because of the presence of political opposition and the freedom to expose government actions. CBI in democracies should be directly reflected in lower money supply growth. Besides being more disciplinarian, it also ensures a more robust money demand by reducing inflation expectations and, therefore, inflation. Empirical results are robust and support a discipline effect conditioned by political institutions, as well as a credibility effect.

Suggested Citation

  • Bodea, Cristina & Hicks, Raymond, 2015. "Price Stability and Central Bank Independence: Discipline, Credibility, and Democratic Institutions," International Organization, Cambridge University Press, vol. 69(1), pages 35-61, January.
    • Handle: RePEc:cup:intorg:v:69:y:2015:i:01:p:35-61_00
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