Central bank autonomy: lessons from global trends.

A large body of research has suggested that central bank autonomy (CBA) may have significant benefits for macroeconomic performance. (1) CBA may help countries achieve lower average inflation, cushion the impact of political cycles on economic cycles, enhance financial system stability, and boost fiscal discipline without any real additional costs or sacrifices in terms of output volatility or reduced economic growth. (2)

Although several studies have documented recent trends in CBA for selected groups of countries, no analysis of worldwide trends has yet been carried out. (3) In an effort to fill this gap. we calculate indexes of de jure CBA for 163 central banks, representing 181 countries, as of end-2003. (4) We also construct comparable indexes of CBA for a subgroup of 68 central banks as of the end of the 1980s. The cross-country and time-series dimensions of this new data set enable us to draw several important lessons from global trends in CBA over the past couple of decades:

* Central banks in advanced economies continue to enjoy greater CBA than those in emerging markets and developing countries. However, at the end of 2003, all country groups exhibit a higher level of CBA than that reached by advanced economies in the late 1980s.

* A vast majority of central banks have been mandated to set price stability as one of the objectives of monetary policy. In addition, most central banks have autonomy with respect to setting the policy rate and are not required to extend direct credit to the government.

* There is divergence among central banks on the issue of financial supervision. Many central banks in emerging markets and developing countries have retained their key role in supervisory activities; in addition, central banks in a few large advanced countries have also retained some form of involvement in financial supervision. In fact, it is not infrequent for central bank laws to prescribe the soundness of the financial system as an objective that is subordinated to medium-term price stability.

* Participation in currency unions has helped to enhance the autonomy of central banks, both among advanced economies (as in the case of the European System of Central Banks--ESCB) and developing countries (Central Bank of West African States--BCEAO; the Bank of Central African States--BEAC; and the Eastern Caribbean Central Bank--ECCB) In the group of developing countries, this is because participation in a currency union has been beneficial for the development of financial markets, which in turn had been a prerequisite for the elimination of direct central bank credit to the government (or central bank participation in the primary market for government securities).

A number of emerging market and developing countries continue to strengthen their instrument autonomy. However, looking forward, the main challenge will be to further boost the political autonomy of centralbanks, mainly by ensuring that central bank governing bodies are appointed without much political interference and for longer terms.