Declarations Are Not Enough: Financial Sector Sources of Central Bank Independence

This paper seeks to explain the pattern of central bank independence prior to the recent fashion for its adoption. The sources of central bank independence matter for economic outcomes because it is by no means clear that such independence is self-enforcing. Since central bankers know that exercise of their independence can be curtailed, they will only pursue counterinflationary policies consistently when there exists an interest group that can protect them politically from the costs of doing so. This paper argues that the financial sector is the most prominent such group, and that central bank independence-and inflation-varied across countries from 1950 to 1989 according to national differences in effective financial opposition to inflation. The results of this analysis have two major policy implications: (1) moves to central bank independence in countries where appropriate political support does not exist may not reduce inflation over the long term; (2) financial deregulation will affect inflation levels in previously unrecognized ways.