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The political economy of reforms in Central Bank design

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What explains the worldwide changes in central bank design over the past five decades? Davide Romelli discusses new dynamic index of central bank independence and show that status quo, as well as regional convergence, represent important drivers of changes in central bank design.

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The paper discusses the significant reforms in central banking over the past 50 years, focusing on the relationship between central bank independence (CBI) and macroeconomic variables. The author notes existing literature suggests a negative relationship between CBI and inflation, particularly in advanced economies. However, previous studies often overlooked CBI as an endogenous variable, failing to address the contextual factors driving reforms in central bank institutional design.

The author's research, which involves a dataset covering 154 countries from 1972 to 2017, aims to identify the drivers of these reforms by incorporating a comprehensive analysis of central bank legislations. The methodology includes creating an index of CBI that reflects contemporary developments and characteristics not considered in older indices.

The findings reveal that countries experiencing lower levels of independence are more likely to reform. External pressures, such as IMF programs and convergence requirements for joining monetary unions, significantly influence the likelihood of reform. Interestingly, the study identifies peer effects, where countries lagging behind in CBI are driven to catch up with their peers.

The implications of the research highlight the importance of considering the endogeneity of CBI when analyzing its effects, suggesting that reforms are contingent upon political and economic contexts. The results contribute to the understanding of the political economy of reforms by emphasizing that institutional changes evolve based on dynamic conditions rather than being fixed or exogenous.

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X-TIMESTAMP-MAP:LOCAL=00:00:00.000,MPEGTS=900000

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The context of this paper stems from, the large number

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of reforms that took place, among central banks

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around the world over the last, 50 years.

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So, just to give you the context of this project started,

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my, this project was motivated by my interest in trying

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to, reestablish the link

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between Central Bank independence

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and other macroeconomic variables,

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which had been largely studied, start,

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since the, the nineties.

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Um, so by reviewing this literature, I, I noticed

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that there was an extensive literature, trying

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to understand the, the, the relationship

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between central bank independence and inflation,

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but also other macroeconomic variables.

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So this literature came

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to a almost clear conclusion on the fact that there existed,

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negative relationship between central bank independence

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and inflation, especially among, advanced economies.

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However, one of the, the main drawback of this literature,

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from my point of view, was related to the fact that,

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none of these, the studies

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that I've seen published in this literature were actually

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considering, the degree of central bank independence

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as an endogenous variable in the sense that, all

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of the papers were taking Central Bank independence

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as given, while not, trying

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to understand which were the, political

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or economic drivers of reforming central bank,

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institutional design.

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So I started this paper by, with an ambitious aim of,

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proposing the first study on, the drivers

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of reforming central bank institutional design

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for a large set of countries, which,

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and I ended up having a final sample

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of 154 countries over the period, 1972,

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up until, 2017.

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The dataset, here is a, a little disclaimer.

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I, I'm, I am, so the, the, the replication, data for,

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for the paper already available online,

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but I'm, I will sure,

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shortly release also the entire database

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in terms of legislation.

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And, the, the motivation is related to the fact

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that in order to create my database,

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the first exercise I had, I had

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to do was basically collect all the central

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bank legislations, right?

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And so when we think about data collection, is, is easy.

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For example, if we want to collect data from, GDP

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to go on IMF or the World Bank websites, download this data

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and implement our analysis.

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However, for Central Bank legislations,

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not even the Central Bank's websites,

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were providing the legislation.

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So if we think about a sample of around 150 countries,

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it'll be easy to, open the link

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to the Central Bank websites, go under,

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legislation section and download this document.

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Unfortunately, this was a, a more tedious exercise

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because, what, during the, the years of my PhD,

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I first had to collect, this

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Legislation by con contacting not only the central bank,

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but also other, governmental institutions.

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And so I first, collected this large database of around,

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2,500 documents.

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And, and, once the data collection

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or the, the legislation collection was implemented,

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I asked myself, how can I, create a measure

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of central bank independence,

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which is inclusive in the sense that it's able

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to capture not only the information

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that were the main characteristics of Central Bank as

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of the 1990s, when these first indexes

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of central bank independence were created,

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but also contemporaneous.

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And so, my start, the starting point,

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for the creation of my index was first of all, try

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to identify the main characteristics which were present in

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the Greeley machine, Rini paper that was published in 1991,

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and the procure, webinar Apti paper published in 1992.

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And then also incorporate, so extend these indexes

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with more characteristics,

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and also incorporate some of the characteristics,

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of central bank design,

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which were not present in the nineties.

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And importantly, these characteristics were represented

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by Central Bank financial independence,

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which became important, especially

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after the global financial crisis

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and, central bank accounting and, reporting

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and disclosure more in general.

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And so, once I've defined, just to give you a little

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of the story of how I, I did basically

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for every central bank

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and for every legislation, I did an extensive review

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of all the literature on Central Bank, accountability,

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independence, and transparency.

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I came up with a list of 160 questions.

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So I end a cheat sheet for every, legislation

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and for every legislation, I had a sense of questions

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and various options, which are categorical variables,

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which will allow me basically to,

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understand the different decrees

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of central bank independence of a country.

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And so, once I, collected all these information,

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I needed actually to convert these categorical variables

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into a real index, right?

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And so, the first thing, I, I, I needed to do is

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to trim down the set of questions to those

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that were possible to be quantified, rather than a yes

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or no or descriptive questions.

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And so I came up with a final list of 42,

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subcategories, which were divided into six

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broader, areas.

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So the six broader areas included, the classical areas,

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that were the four classical areas

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that were already discussed in previous indexes, which were,

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central bank,

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all the characteristics on central bank governance,

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monetary policy implementation, the central bank objective,

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and lending to the governments,

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which were present in both the Greeley machine, notit, Bini,

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and the procurement web, web and AAPT paper.

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And then what I also did, I added this new subsection

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or two dimension, on,

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central bank financial independence and accountability.

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And so once I had this, this data, I actually try

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to understand where, how can we identify reforms, right?

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As I said before, every time a legislation changed, right?

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Not only a new legislation was enacted,

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but also an amendment was brought to the legislation,

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I basically recomputed my index, right?

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And so, being able to, to make this process automatic,

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I was actually able to look at,

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the variation in the index

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and identify the number of reforms.

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So this allowed me for the sample

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of 155 countries in my sample, to have

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to identify the largest number of reforms,

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which could ever be, identified in, in the literature.

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When, I had a total number of,

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286 reforms implemented, over the period

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of my analysis, the data collection parts took a large,

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amount of, of my time during the PhD.

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But afterwards, what I tried to, I wanted

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to do was actually to try to understand,

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which were the drivers.

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So I, I use, the,

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the large literature in the political economy of reform.

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And so try to understand not only on central bank,

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design, but also on other characteristics of a country

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to understand, which could be the, the elements

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that influence reforms, right?

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And so I started collecting, possible, drivers

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and possible, elements that my influence.

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And so, among the characteristics I, I, I started,

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that were present in this literature, there was the evidence

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that the status quo bias, so the level of, independence

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or the level of, development

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of a country might influence, the propensity

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and the trade off implement

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of implementing our reform, right?

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So the first measure of status quo bias

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that is used in the paper is the lag level of,

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central bank independence.

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But other elements are important.

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So when it comes to national

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and international, institutions, we know that, some

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external pressure, comes at play, right?

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So there are already established paper in the literature

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that we're suggesting that, the,

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there is an important drivers of international organization,

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which can boost reforms.

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When we think about the extended Washington consensus,

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we know that typically, countries

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that re receive an IMF support are more, more likely to,

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to implement rebel liberalization reforms, right?

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And so, and a possible driver of,

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of reforming central bank design was, the effects on,

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creating sim.

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First of all, Adam Damion, whether the country,

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was under or, or not under, or not an IMF program.

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So this is the first measure of external inducement.

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Uh, another pressure that can come at play is the fact that,

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if we think a bit about, for example,

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Euro area countries, we know that in terms

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of four countries, in order to be able

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to join the Euro area, they need to follow certain

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convergence in the reform process.

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And so, being, a country which is eligible

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to enter a monetary union, we can have as a,

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an additional, element of pressure.

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And a final element of PR pressure is, is captured,

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by looking, for example, at the, the famous, paper

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by does democracy grow growth,

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on the peer pressures coming from, the, the lever, the,

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the distance between, the, the degree of independence

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of the central bank and,

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and the peers in their same regions, right?

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And so this is the, the third measures,

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but then there are other elements.

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Uh, so for example, there was this, idea,

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and there is, especially the

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after the global financial crisis that,

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people were asking on whether, crisis,

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cause or reforms, right?

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So it's easier to implement austerity measure

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or tough reforms during period of crisis.

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So I also control for measures such

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as hyperinflation periods, financial crisis,

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currency and debt crisis.

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And then, in the last part of the,

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the additional set of control, I also control for, the,

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the political institutions.

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Uh, so for example, for using the policy index,

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but also some economic characteristics.

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For example, the level of, debt to GDP

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and an index of globalization.

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So, in, in my point, from my point of view, I, I started

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with this agnostic view in trying to,

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not put any prior on what I would expect.

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Uh, I, I added these variables as a potential control,

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and I was curious even myself, to try

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to understand which could be the main drivers of reforms.

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The findings are, are pretty straightforward.

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They, they suggest that, the large number

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of robustness check that I have implemented,

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I find large evidence on the fact that both intern national

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and external, so internal

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and external factors are large driver of reforms.

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So there is an unconditional doubt on the fact that,

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countries that are more likely

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to reforms are those countries that are characterized

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by a lower level of independence.

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So we see these trend in independence,

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and so not surprisingly, we find that countries

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that are less, independent are the, the one

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that are more likely to reform.

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But at the same time, we also find that, countries

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that are under an IMF program

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or are, soon to, to be joining a monetary union,

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are more likely to reform

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and in line also with the paper, of h mog loan reforms.

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Uh, what we also find is that basically, countries

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that are characterized by a lower level of independence

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as compared to their peer, they are more likely to reform.

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So there is this idea of a peer effect

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or catch up effect that countries that are left

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behind in terms of independence, when it is the time

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to reform, they will be the one that are reforming their,

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their independence the most.

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And then there are also some, some other interesting facts

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that we can, we can find.

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We don't find much of a results when we look at the entire,

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process, of reforms driven by,

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global financial crisis,

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or, banking, currency crisis or type crisis.

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Undoubtedly, we find that,

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I hyperinflation episodes are associated

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with period of reforms.

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So, this happened in a few set of countries,

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when it, we narrow wrote down the analysis to,

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not only at the, at the magnitude,

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but also in the direction of reforms.

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We find that typically negative reforms

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or, re reversal in central bank

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independence are more likely to happen during a,

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after a financial crisis as it happened, during the,

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the post, global financial crisis.

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And, probably, the, some,

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there are some other elements that, that we can find.

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For example, when we look at the results, for,

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advanced economies, we find that,

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government changes are,

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important in driving reforming central bank independence.

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If you think about the United Kingdom in 1997,

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after the, the appointment of a new government,

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while when it comes to, developing countries, we find

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that, the results are mainly driven

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by the peer pressure coming from IMF programs.

13:53.985 --> 13:55.325
The conclusion of implication

13:55.345 --> 13:57.845
and implication of our paper, are,

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pretty straightforward, on top of, showing that,

14:02.665 --> 14:06.365
it is important to, when, when analyzing the degree

14:06.365 --> 14:08.405
of central bank independence of a country,

14:08.475 --> 14:12.565
it's also important to take into account, the, the,

14:12.565 --> 14:14.285
the endogeneity of these variables.

14:14.305 --> 14:15.845
So, the, the results

14:15.865 --> 14:18.805
and this dynamic index, which is publicly available online,

14:19.265 --> 14:22.405
should serve as a good instrument to,

14:22.465 --> 14:24.885
to capture the degree of central bank independence

14:25.145 --> 14:26.205
and more, Bo broadly.

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Our, this paper speaks to the,

14:28.885 --> 14:31.645
to the literature on the political economy of reforms,

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and basically shows that, political,

14:36.085 --> 14:39.085
institutions, right, are political

14:39.085 --> 14:41.685
and economic institutions such as, central banks

14:41.705 --> 14:45.645
or other, institutions are, are not, con,

14:45.645 --> 14:47.405
should not be always considered

14:47.405 --> 14:50.205
as a exogenous variable while implementing any type

14:50.205 --> 14:53.685
of analysis, but actually, their, their characteristics

14:53.705 --> 14:55.805
and their dynamics evolve endogenously,

14:55.805 --> 14:57.725
depending on the political

14:57.725 --> 14:59.885
and economic conditions of a country.

00:00 - The context of this paper stems from, the large number of reforms that took place, among central banks around the world over the last, 50 years. So, just to give you the context of this project started, my, this project was motivated by my interest in trying to, reestablish the link

00:19 - between Central Bank independence and other macroeconomic variables, which had been largely studied, start, since the, the nineties. so by reviewing this literature, I, I noticed that there was an extensive literature, trying to understand the, the, the relationship between central bank independence and inflation, but also other macroeconomic variables. So this literature came

00:43 - to a almost clear conclusion on the fact that there existed, negative relationship between central bank independence and inflation, especially among, advanced economies. However, one of the, the main drawback of this literature, from my point of view, was related to the fact that, none of these, the studies that I've seen published in this literature were actually considering, the degree of central bank independence as an endogenous variable in the sense that, all of the papers were taking Central Bank independence

01:16 - as given, while not, trying to understand which were the, political or economic drivers of reforming central bank, institutional design. So I started this paper by, with an ambitious aim of, proposing the first study on, the drivers of reforming central bank institutional design for a large set of countries, which, and I ended up having a final sample of 154 countries over the period, 1972,

01:46 - up until, 2017. The dataset, here is a, a little disclaimer. I, I'm, I am, so the, the, the replication, data for, for the paper already available online, but I'm, I will sure, shortly release also the entire database in terms of legislation. And, the, the motivation is related to the fact that in order to create my database, the first exercise I had, I had

02:12 - to do was basically collect all the central bank legislations, right? And so when we think about data collection, is, is easy. For example, if we want to collect data from, GDP to go on IMF or the World Bank websites, download this data and implement our analysis. However, for Central Bank legislations, not even the Central Bank's websites, were providing the legislation. So if we think about a sample of around 150 countries,

02:41 - it'll be easy to, open the link to the Central Bank websites, go under, legislation section and download this document. Unfortunately, this was a, a more tedious exercise because, what, during the, the years of my PhD, I first had to collect, this Legislation by con contacting not only the central bank, but also other, governmental institutions. And so I first, collected this large database of around, 2,500 documents.

03:12 - And, and, once the data collection or the, the legislation collection was implemented, I asked myself, how can I, create a measure of central bank independence, which is inclusive in the sense that it's able to capture not only the information that were the main characteristics of Central Bank as of the 1990s, when these first indexes of central bank independence were created, but also contemporaneous.

03:39 - And so, my start, the starting point, for the creation of my index was first of all, try to identify the main characteristics which were present in the Greeley machine, Rini paper that was published in 1991, and the procure, webinar Apti paper published in 1992. And then also incorporate, so extend these indexes with more characteristics, and also incorporate some of the characteristics, of central bank design, which were not present in the nineties.

04:09 - And importantly, these characteristics were represented by Central Bank financial independence, which became important, especially after the global financial crisis and, central bank accounting and, reporting and disclosure more in general. And so, once I've defined, just to give you a little of the story of how I, I did basically for every central bank and for every legislation, I did an extensive review

04:38 - of all the literature on Central Bank, accountability, independence, and transparency. I came up with a list of 160 questions. So I end a cheat sheet for every, legislation and for every legislation, I had a sense of questions and various options, which are categorical variables, which will allow me basically to, understand the different decrees of central bank independence of a country. And so, once I, collected all these information,

05:07 - I needed actually to convert these categorical variables into a real index, right? And so, the first thing, I, I, I needed to do is to trim down the set of questions to those that were possible to be quantified, rather than a yes or no or descriptive questions. And so I came up with a final list of 42, subcategories, which were divided into six broader, areas. So the six broader areas included, the classical areas,

05:39 - that were the four classical areas that were already discussed in previous indexes, which were, central bank, all the characteristics on central bank governance, monetary policy implementation, the central bank objective, and lending to the governments, which were present in both the Greeley machine, notit, Bini, and the procurement web, web and AAPT paper. And then what I also did, I added this new subsection or two dimension, on,

06:07 - central bank financial independence and accountability. And so once I had this, this data, I actually try to understand where, how can we identify reforms, right? As I said before, every time a legislation changed, right? Not only a new legislation was enacted, but also an amendment was brought to the legislation, I basically recomputed my index, right? And so, being able to, to make this process automatic, I was actually able to look at, the variation in the index

06:38 - and identify the number of reforms. So this allowed me for the sample of 155 countries in my sample, to have to identify the largest number of reforms, which could ever be, identified in, in the literature. When, I had a total number of, 286 reforms implemented, over the period of my analysis, the data collection parts took a large, amount of, of my time during the PhD. But afterwards, what I tried to, I wanted

07:10 - to do was actually to try to understand, which were the drivers. So I, I use, the, the large literature in the political economy of reform. And so try to understand not only on central bank, design, but also on other characteristics of a country to understand, which could be the, the elements that influence reforms, right? And so I started collecting, possible, drivers and possible, elements that my influence.

07:35 - And so, among the characteristics I, I, I started, that were present in this literature, there was the evidence that the status quo bias, so the level of, independence or the level of, development of a country might influence, the propensity and the trade off implement of implementing our reform, right? So the first measure of status quo bias that is used in the paper is the lag level of, central bank independence.

08:03 - But other elements are important. So when it comes to national and international, institutions, we know that, some external pressure, comes at play, right? So there are already established paper in the literature that we're suggesting that, the, there is an important drivers of international organization, which can boost reforms. When we think about the extended Washington consensus, we know that typically, countries

08:31 - that re receive an IMF support are more, more likely to, to implement rebel liberalization reforms, right? And so, and a possible driver of, of reforming central bank design was, the effects on, creating sim. First of all, Adam Damion, whether the country, was under or, or not under, or not an IMF program. So this is the first measure of external inducement. another pressure that can come at play is the fact that, if we think a bit about, for example,

09:03 - Euro area countries, we know that in terms of four countries, in order to be able to join the Euro area, they need to follow certain convergence in the reform process. And so, being, a country which is eligible to enter a monetary union, we can have as a, an additional, element of pressure. And a final element of PR pressure is, is captured, by looking, for example, at the, the famous, paper by does democracy grow growth,

09:35 - on the peer pressures coming from, the, the lever, the, the distance between, the, the degree of independence of the central bank and, and the peers in their same regions, right? And so this is the, the third measures, but then there are other elements. so for example, there was this, idea, and there is, especially the after the global financial crisis that, people were asking on whether, crisis,

10:03 - cause or reforms, right? So it's easier to implement austerity measure or tough reforms during period of crisis. So I also control for measures such as hyperinflation periods, financial crisis, currency and debt crisis. And then, in the last part of the, the additional set of control, I also control for, the, the political institutions. so for example, for using the policy index,

10:31 - but also some economic characteristics. For example, the level of, debt to GDP and an index of globalization. So, in, in my point, from my point of view, I, I started with this agnostic view in trying to, not put any prior on what I would expect. I, I added these variables as a potential control, and I was curious even myself, to try to understand which could be the main drivers of reforms. The findings are, are pretty straightforward.

11:02 - They, they suggest that, the large number of robustness check that I have implemented, I find large evidence on the fact that both intern national and external, so internal and external factors are large driver of reforms. So there is an unconditional doubt on the fact that, countries that are more likely to reforms are those countries that are characterized by a lower level of independence. So we see these trend in independence,

11:34 - and so not surprisingly, we find that countries that are less, independent are the, the one that are more likely to reform. But at the same time, we also find that, countries that are under an IMF program or are, soon to, to be joining a monetary union, are more likely to reform and in line also with the paper, of h mog loan reforms. what we also find is that basically, countries that are characterized by a lower level of independence

12:07 - as compared to their peer, they are more likely to reform. So there is this idea of a peer effect or catch up effect that countries that are left behind in terms of independence, when it is the time to reform, they will be the one that are reforming their, their independence the most. And then there are also some, some other interesting facts that we can, we can find. We don't find much of a results when we look at the entire, process, of reforms driven by,

12:36 - global financial crisis, or, banking, currency crisis or type crisis. Undoubtedly, we find that, I hyperinflation episodes are associated with period of reforms. So, this happened in a few set of countries, when it, we narrow wrote down the analysis to, not only at the, at the magnitude, but also in the direction of reforms. We find that typically negative reforms

13:04 - or, re reversal in central bank independence are more likely to happen during a, after a financial crisis as it happened, during the, the post, global financial crisis. And, probably, the, some, there are some other elements that, that we can find. For example, when we look at the results, for, advanced economies, we find that, government changes are, important in driving reforming central bank independence.

13:37 - If you think about the United Kingdom in 1997, after the, the appointment of a new government, while when it comes to, developing countries, we find that, the results are mainly driven by the peer pressure coming from IMF programs. The conclusion of implication and implication of our paper, are, pretty straightforward, on top of, showing that, it is important to, when, when analyzing the degree of central bank independence of a country,

14:08 - it's also important to take into account, the, the, the endogeneity of these variables. So, the, the results and this dynamic index, which is publicly available online, should serve as a good instrument to, to capture the degree of central bank independence and more, Bo broadly. Our, this paper speaks to the, to the literature on the political economy of reforms, and basically shows that, political,

14:36 - institutions, right, are political and economic institutions such as, central banks or other, institutions are, are not, con, should not be always considered as a exogenous variable while implementing any type of analysis, but actually, their, their characteristics and their dynamics evolve endogenously, depending on the political and economic conditions of a country.

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