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Central bank transparency and inflation (volatility) – new evidence

Abstract

The last decades have shown a tendency towards higher central bank transparency. This leads to the question of how central bank transparency is entangled with price stability and inflation volatility. A plethora of studies analysed the relationship from a theoretical point of view and came to contradictory results. Thus, the article aims to analyse this question empirically and to better understand the mechanism behind it. Firstly, the results show that transparency reduces inflation expectations and inflation even if we control for other determinants. However, transparency alone is not sufficient to produce stable prices. Secondly, the paper proves that the effect on inflation mainly comes from reduced inflation expectations. Thirdly, we show that central bank transparency seems to diminish inflation uncertainty. This confirms the economic importance of central bank transparency.

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Notes

  1. 1.

    Rough and ready definitions of the two concepts are that central bank transparency refers to the overall information provision by the central bank whereas central bank independence means that the central bank can take its decisions without direct influence from the government. More sophisticated definitions of the concepts can be found in Section 3 where we show how the two concepts are operationalised.

  2. 2.

    This refers to the problem of central bank accountability. There is no unanimous definition of central bank accountability. De Haan et al. (1999) argue that accountability has three aspects: a clear definition and prioritisation of monetary policy goals, central bank transparency, and a clear assignment of responsibility. According to their measure, there is a slight negative correlation between CBI and central bank accountability.

  3. 3.

    The Fry et al. (2000) accountability index is somewhat different from the De Haan et al. (1999) index. It only considers legal ties between central bank and government regarding the main target and the responsibility of the central bank with respect to government and parliament.

  4. 4.

    There is a clear negative relation between GDP per capita and the share of food in CPI baskets (Yörükoglu 2010).

  5. 5.

    At the same time, exchange rate changes can have an impact on the real economy. For developing countries, devaluations could be contractionary as Chou and Chao (2001) show. However, other studies do not find evidence for contractionary effects of devaluations in developing countries (e.g. Narayan and Narayan 2007).

  6. 6.

    Daniels et al. (2005) give a good overview of the theoretical discussion about the relationship between openness and inflation.

  7. 7.

    According to Batchelor and Dua (1996), these measures are only indirect measures of inflation uncertainty that are not highly correlated with direct measures for inflation uncertainty. Thus, we have to be cautious when interpreting inflation volatility as inflation uncertainty.

  8. 8.

    In the cases where no convergence for the GARCH models was achieved, we eliminated the AR(1) from the estimation of the inflation rate. This should not be problematic as we include country fixed effects in the estimation of the determinants of inflation volatility.

  9. 9.

    The results are available upon request.

  10. 10.

    Of course, one can question this presumption. Berlemann (2005) shows in a sample of six countries that public attitudes towards price stability do change over time. These variations in preferences affect inflation in three out of six countries. Nonetheless, we stick to our assumption of relatively stable inflation cultures.

  11. 11.

    One might argue that there was not much variation in CBI between 1998 and 2010. Albeit there was more variation in CBT, the vast majority of countries (over 70 %) experienced changes in CBI.

  12. 12.

    These results are available in the Appendix Table 7.

  13. 13.

    The other results are available upon request.

  14. 14.

    The exceptions are estimations Vol2 and Vol8.

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Acknowledgments

The author wishes to thank Jürgen Kähler, an anonymous referee, and participants of the 20th BGPE Research Workshop and the ECPR Graduate Student Conference 2016 for very useful comments and suggestions.

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Correspondence to Christoph S. Weber.

Appendix

Appendix

Table 7 Determinants of inflation (including inflation expectations)

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Weber, C.S. Central bank transparency and inflation (volatility) – new evidence. Int Econ Econ Policy 15, 21–67 (2018). https://doi.org/10.1007/s10368-016-0365-z

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Keywords

  • Central bank transparency
  • Inflation
  • Inflation volatility
  • Determinants of inflation
  • Central bank independence

JEL classification

  • E31
  • E42
  • E58