Central Bank Independence: Reassessing the Measurements

Author(s): James Forder

Source: Journal of Economic Issues, Vol. 33, No. 1 (Mar., 1999), pp. 23-40
Published by: Taylor & Francis, Ltd.
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J JOURNAL OF ECONOMIC ISSUES
Vol. XXXIII No. 1 March 1999

Central Bank Independence: Reassessing the Measurements

James Forder

The hypothesis that central bank independence improves macroeconomic per-

formance is an alluring one. It is, in the first place, readily grounded in theory:
elected governments, periodically needing to face their electorates, have an incen-
tive to overinflate, but independent monetary authorities-having other, more pub-
lic-spirited objectives-can protect them from temptation. It also offers not only a
description of economic ills, but a remedy too: legislate to make central banks more
independent. So the science of economics advances: first it explains, then it con-
trols. 1
Beside the theoretical allure, however, lies an empirical difficulty. If we are to
test the independence hypothesis, we must first construct a measure of inde-
pendence, and it is not a priori clear how to do this. The approach followed most
often is to seek to measure relative degrees of independence by comparing the stat-
utes of central banks.2 However, even this narrowing of attention to statutory char-
acteristics leaves a number of awkward judgments to be made as to which
characteristics of the statutes are relevant and how they are to be weighted or
bined.
The existence of a difficulty is widely accepted in the literature. For examp
A. Alesina [1988, 40] begins by acknowledging that quantifying the elements that
determine independence is difficult. He points to the large literature debating the ex-
tent to which the Federal Reserve is really independent of the president and Con-
gress and describes the approach of M. Parkin and R. Bade [1985], which he
largely follows, as "courageous." In the same spirit, having listed their criteria of
independence, V. Grilli, D. Masciandaro, and G. Tabellini [1991, 367] concede
that "combining them is unavoidably arbitrary so we adopt the simplest procedure of
adding them up." Similarly, A. Cukierman, S. Webb, and B. Neyapti [1992, 383]

The author is Fellow and Tutor in Economics, Balliol College, Oxford.

23

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 24 James Forder

state that "unavoidably, there were subjective or arbitrary decisions in coding, class-
ifying, and weighing legal information."3 A. Alesina and L. Summers [1993, 3] in
fact go further, asserting that "the central difficulty in examining the question of
central-bank independence is measuring the independence of the central-bank in dif-
ferent countries."
Notwithstanding these difficulties, it is striking that the literature appears to have
reached a consensus that independence does improve performance. Alesina [1988,
41-42] concludes that

broadly speaking, there is an inverse relationship between the degree of inde-

pendence of Central-banks and the average inflation rate. The two countries
with the most independent Central-banks had the lowest inflation. The most
dependent Central-banks (group 1) had some of the highest inflation rates.

Grilli, Masciandaro, and Tabellini [1991, 375] similarly assert that "central-
bank independence is on average associated with lower inflation," and Cukierman,
Webb, and Neyapti [1992, 355-6] said that "examining the relation of inflation to al-
ternate indicators for independence reveals that legal [= statutory] independence is
an important determinant of inflation in the industrial countries."
And, unsurprisingly, this agreement is commented on by several authors. Grilli,
Masciandaro, and Tabellini [1991, 373] wrote: Our results also confirm previous
findings obtained by other authors for a different sample of countries and a slightly
different ranking of independence" [see Parkin and Bade 1982; Alesina 1989].
Alesina and Summers [1993, 4] are at pains to emphasize the similarity of re-
sults: "In our empirical work which follows, we use the average of the two indi-
ces . . . Very similar results are obtained when either scale is used individually. "
Perhaps more importantly, other scholars draw on this literature in making pol-
icy proposals and are frequently impressed by the uniformity of results. A typical
example is A. Busch [1994, 58-9], who said, "Several students have tested the hy-
pothesis of an inverse relationship between the degree of central-bank independence
and the rate of inflation and found empirical support for it." And S. Eijffinger and
J. de Haan [1996, 40], in what is at present the most complete survey of empirical
work on central bank independence, assert that "overwhelming evidence exists that
central-bank independence and inflation are negatively related."4 Beyond those who
directly refer to the research in question, there are many who have become con-
vinced of the benefits of independence.5
We are left with the conclusions then that, although measuring independence is
difficult, the weight of evidence strongly suggests independence is associated with
lower inflation. One implication is that the difficulty in designing measures of inde-
pendence is more apparent than real. Although it is initially a source of concern,
happily, all reasonable studies point in the same direction, and so the measurement
problem need not lead to serious doubts about the conclusion.

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 Central Bank Independence: Reassessing the Measurements 25

It is my objective to challenge this happy view and to argue that the problem of
measuring central bank independence is substantially greater than these authors have
realized. Second, the apparent agreement of the studies under consideration offers
no comfort. Indeed, this agreement is, in the relevant sense, an illusion.
The scale of the problem becomes apparent once we recognize its nature. What
we require of a measure of independence is that it be the empirical correlate of the
theoretical notion called "independence," which it is suggested may bring benefits.
With such a measure we could test the theory. What has escaped attention is that
having constructed a measure of independence by the statute-reading methodology,
prior to using it to test the claim that independence leads to lower inflation, we need
a way of assessing whether the measure does in fact capture the empirical behavior
called "independent" by the theory. No such attempt to assess the measure before
using it to test the hypothesis is made in the studies under consideration, nor, gener-
ally speaking, in the wider literature on central bank independence.
I look at this problem from two angles. First, I consider the problem of testing
the independence hypothesis. The difficulty of knowing a good measure from a bad
one shows up here as the difficulty of knowing whether an apparent falsification of
the independence hypothesis-that is, a result that shows independence is not related
to inflation-is attributable to the hypothesis being false or the measure of inde-
pendence being defective.
The second perspective is that of a comparison of different measures of inde-
pendence. At first sight, the agreement of various authors, using different measures,
suggests that measurement problems are unimportant. We do not know just how to
weight this characteristic or whether to include that one, but, luckily, it does not
matter much. The result is resilient: all the measures used are reasonable, and they
all point the same way, so whatever inadequacies they have need not worry us.
It becomes clear that this conclusion is not warranted when we distinguish three
things: different approaches to measurement, different resultant measures, and dif-
ferent results from comparing the resultant measures with inflation. The studies in
question use different approaches and get broadly the same results. The key point
that is often overlooked is that the different approaches give rise to different resul-
tant measures, pointing to the fact that there is no agreement as to the empirical con-
tent of the notion of "independence."
My conclusions are that, all in all, the literature under consideration has fallen
well short of what is routinely claimed for it: the difficulties in measuring inde-
pendence have not been sufficiently overcome to allow persuasive or meaningful
tests of hypotheses about it to be undertaken. The source of this weakness is the fail-
ure to present a means of identifying a good measure of independence. Further, the
difficulties in making such an identification are formidable. It may be that they can-
not be satisfactorily overcome.

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 26 James Forder

I focus on three approaches to

use the statute-reading methodo
known studies, as well as the on
range of statutory data. They ar
and used by Alesina [1988, 1989]
M. Emerson et al. [1992]. I call it A/PB. The next, GMT, is by Grinli, Mascian-
daro, and Tabellini [1991], and then I turn to CWN, undertaken by Cukierman,
Webb, and Neyapti [1992], which is a far more detailed study that includes a much
larger group of countries.6

Is the Independence Hypothesis Falsifiable?

The Literature

When a hypothesis is tested, it is a matter of some importance what result will

lead to the conclusion that it is false. In the case of central bank independence, how-
ever, there has been a tendency to fall into the trap of treating the "test" as identify-
ing the appropriate measure of independence-that is, of identifying a "measure"
that is in fact related to inflation and then calling it "independence." Thus, for ex-
ample, Parkin and Bade [1988, 24] said:

It seems that central bank laws only influence inflation in the case of the ex-
tremely independent central bank type prevailing in Germany and Switzer-
land. The critical element that distinguishes that case from the others is that
the central bank is independent in the double sense that its policy inde-
pendence is explicitly provided for in the statute and also, the key distin-
guishing characteristic, that the appointments of board members in those two
banks are not entirely controlled by governments of those countries.

Here, West Germany and Switzerland have been singled out as special cases,
with lesser degrees of independence not thought to make a significant difference.
The important point, however, is that Parkin and Bade's conclusion could be
thought of as the discovery of a characteristic shared by the two countries with the
lowest inflation. Of course, the characteristic they identify is one that seems plausi-
ble as an important characteristic of independent central banks, but my point is that
no test can really be said to have been performed. On this approach, the only way
that the hypothesis that independence reduces inflation could have been falsified is if
no suitable characteristic or combination of characteristics was shared by these two
central banks-a most improbable outcome. Indeed, the option would still exist of
picking a different set of countries on which to perform the test until a suitable com-
bination of statutory characteristics did appear.

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 Central Bank Independence: Reassessing the Measurements 27

Although Alesina's extension of the analysis does not depend on the existence of
a "key characteristic," he does face the same problem in discussing two "dimen-
sions" of independence in Parkin and Bade [1985]. Alesina said: "They consider
two dimensions of independence-political and financial ... Political independence
appears more relevant, and it is the criterion emphasised in this paper. "7
More precisely, Parkin and Bade [1988, 20] noted that there was "no association
whatsoever" between financial independence and inflation. So Alesina has assumed
that the right measure is the one that gives the expected relationship. Why should it
not be-on an a priori basis-that financial independence is the true determinant of
whether the central bank acts independently, but, as it happens, independent action
does not reduce inflation?
The same problem exists in the study by Cukierman, Webb, and Neyapti. This
study goes beyond purely institutional data and considers the turnover of central
bank governors and the result of surveys of central bank staff on their impressions
of the degree of political influence on the central bank. They also extend the re-
search to a larger set of countries, including a large number of developing countries.
As a consequence of this, Cukierman et al. [1992, 355] say, "The wider sample
makes it possible to examine whether there are systematic differences in central
bank independence between industrial and developing countries."
However, when it comes to the results of their study, Cukierman et al [1992,
383] concluded: "Legal [= statutory] independence is an important and statistically
significant determinant of price stability among industrial countries, but not among
developing countries" and "the turnover rate [of the Governors] was not significant
in explaining variations of inflation within the industrial group."
What they conclude from this is that turnover rates are not a determinant of in-
dependence, whereas the most they can be said to have found is that it is not a deter-
minant of inflation. Similarly, although a plausible theoretical reason can be
advanced to think that independence will not improve performance in less developed
countries (say, fragile democratic institutions make it difficult to sustain inde-
pendence), one could equally well advance theoretical reasons to think independence
will be less important in the developed world (say, more educated voters will punish
governments for poor management of the economy).8 Again, a priori, there is no
convincing reason to draw the distinction that is, in fact, drawn only after the data
have been inspected. It cannot be said that this process is a test.

Interpretation

None of these papers presents a true test of the independence hypothesis. They
have, in various ways, identified more or less plausible proxies for independence
that are related to inflation; but in the process they have identified equally plausible
proxies that are not. Clearly, there are no grounds for selecting the first over the

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 28 James Forder

second as the appropriate prox

pendence reduces inflation. Thi
be rationalized. Certainly it can be rationalized, but alternative rationalizations
pointing to different conclusions could also be offered.
One needs to see this difficulty as fundamental to the approach, not as incidental
and just a characteristic of the implementation of the approach. I have illustrated the
problem by taking examples of plausible measures being rejected because they did
not confirm the hypothesis, but this is only illustrative. It is not the case that, had
the authors been less open in presenting rejected measures, I would have no ammu-
nition. Indeed, Grilli, Masciandaro, and Tabellini do not report the rejection of any
measures of independence for the reason that the measure is unrelated to inflation,
but does that make their measure a good one? No, the fact that it "works" is no rea-
son to think that it captures what the theory means by "independent."
The problem is a methodological one: it lurks beneath the waves. The question
that is not addressed by these authors is, what are the criteria of a good measure? It
cannot be "one which gives a relation with inflation" since that makes the hypothesis
unfalsifiable, nor is it helpful to treat it as being "one that is constructed in a way
we judge to be reasonable" since the "financial independence" from Parkin and
Bade or the turnover rates from Cukierman et al. would pass that test. Nothing
made the construction of these unreasonable. After all, it is because they seemed
reasonable that the authors chose to investigate whether they are related to inflation.
We are lacking neither plausible seeming measures that "confirm" the hypothesis
nor plausible seeming measures that "reject" it.9 What we are lacking is an objec-
tive reason to prefer one over the other. Without this, there can be no test of the in-
dependence hypothesis.10 The difficulty is that a "plausible" measure is one that is
worth testing, but the test that we need to perform is a test of whether the plausible
measure of independence is, in fact, a good measure of independence. And a good
measure of independence is one that measures the extent to which the central bank
behaves in the way the theory calls "independent," not one that is negatively related
to inflation.
I hope it is clear that these tests of the independence hypothesis are in fact not
tests at all. Without a prior justification for the measure of independence, there can
be no test. What is perhaps more open to doubt is whether and how the problem can
be overcome. I suggest that it will be very difficult. Certainly, steps could be taken.
For example, one reason to doubt a measure is that its author may be subject to sub-
conscious influences relating to his or her hopes that the hypothesis will be con-
firmed or rejected. This, combined with knowledge of which countries in fact have
low inflation, points to a possible source of bias. One could perhaps eliminate that
particular source by having central banks ranked according to their statutes by peo-
ple who do not have knowledge of which bank is which. Such a procedure might
avoid the problem of experimenter preconceptions, but it would not answer my

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 Central Bank Independence: Reassessing the Measurements 29

more fundamental point. All we would know is that a certain sort of bias was ab-
sent. But the lack of one kind of bias is not in itself a reason to suppose that the
measure closely reflects the behavior of central banks that have the characteristics of
independence entailed by the theory we are trying to test.

Comparing Measures

The Literature

Each of the tests under consideration seeks to discover whether there is a rela-
tionship between independence and inflation; each measures independence in a dif-
ferent way, and each finds that the expected relationship does exist. Thus, they
appear to be mutually confirming. This seems to challenge the importance of my ar-
gument in the last section. If it is the case that several studies, using different meas-
ures of independence, all come to the same conclusion, it might be that the
difficulties of data selection and weighting are not as great as they seem. 12 If rea-
sonable efforts all point the same way, why should one doubt that is the correct
way? But there is a difficulty with this view, which is obscured by comparing only
the results of the test, but revealed by comparing the measures of independence di-
rectly.
The difficulty is that the various means of measuring independence lead to strik-
ingly different outcomes. The studies agree in ranking Germany and Switzerland as
the most independent, but beyond this there is almost no agreement. This is a point
of great significance since it shows that the studies have widely different under-
standings of what I have argued is the key issue, namely, what constitutes inde-
pendence on an empirical level. For this reason, apparently mutually confirming
studies are more in the nature of being mutually contradictory: the empirical nature
of the "independence" that each one finds to be a determinant of inflation is quite
different, so they should really be thought of as tests of different hypotheses.
The three studies under consideration treat slightly different samples of coun-
tries. Table 1 shows the measure of independence of each study for those countries
appearing in at least two of the studies. Higher numbers are "more independent" in
each case. Table 2 represents the measures in a rank ordering expressed as a "per-
centage" to normalize for different sized samples. (If a central bank is least inde-
pendent out of a sample of 8, it goes down as 12.5 percent).13
At first sight, the studies appear to exhibit some degree of similarity in their
measure of independence, although perhaps not as much as might be expected.
However, a closer look reveals that if we exclude Germany and Switzerland, even
this similarity vanishes.14

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 30 James Forder

The correlation coefficient is

between measures. Between the GMT and CWN measures, the correlation coeffi-
cient is 0.37.15 But leaving Germany and Switzerland out of consideration, it falls
to 0. 16. Similarly, the correlation between A/PB and CWN is 0.43. When leaving
out the same two banks, it falls to a minuscule 0.028. Between GMT and A/PB, the
r2 starts at a slightly more respectable 0.5, but after leaving out Germany and Swit-
zerland, it falls sharply to 0.23.
These results can be appreciated from a visual presentation in the following
three graphs (Figures 1-3), which show the relationship between the three pairs of
measures: first CWN against A/PB, then CWN against GMT, then GMT against

Table 1. Independence Scores

Country GMT CWN A/PB

Norway 0.17 2

Belgium 7 0.17 2
Japan 6 0.18 3
Spain 5 0.23 1
New Zealand 3 0.24 1
France 7 0.25 1
Italy 5 0.25 1.5
United Kingdom 6 0.27 2
Finland 0.28 2
Sweden 0.29 2
Australia 9 0.36 1
Portugal 3 0.41
Netherlands 10 0.42 2
Ireland 7 0.44

Canada 11 0.45 2
United States 12 0.48 3
Denmark 8 0.50 2
Greece 4 0.55
Austria 9 0.61

Switzerland 12 0.64 4
Germany 13 0.69 4

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 Central Bank Independence: Reassessing the Measurements 31

Table 2. Rank Order of Independence (Percent)

Country GMT CWN A/PB

Norway 7 55

Belgium 50 7 55

Japan 36 14 88

Spain 25 19 12

New Zealand 8 26 12

France 50 26 12

Italy 25 33 24

United Kingdom 36 38 55

Finland 43 55

Sweden 48 55

Australia 69 52 12

Portugal 8 57 12

Netherlands 78 62 55

Ireland 50 67

Canada 83 71 55

United States 92 76 88

Denmark 61 81 55

Greece 17 86

Austria 69 90

Switzerland 92 95 100

Germany 100 100 100

A/PB. As I have drawn the graphs, the dotted-line rectangles are a visual aid to as-
sessing the correlations between measures when Germany and Switzerland are ex-
cluded. It is clear that any pair of measures are all but unrelated when these two
countries are excluded.
Of course, one could alternatively improve the r2 by leaving out the countries
where the widest divergence of measures occurs. But this is not really to the point:
my concern is that selection bias is a danger. The independence of the central banks
in Germany and Switzerland is more or less a matter of conventional wisdom-no
one thinks that they learned that these are the most independent central banks by
reading this literature. Thus, in the case of these central banks, the studies conform

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 32 James Forder

to the conventional wisdom. Exclude these, however, and consider cases where
there is little or no conventional wisdom and the similarity of the studies disappears,
suggesting that the "measures" are little better than random. Another way of making
what is really the same point is that it should be a matter of concern that measures
of the same thing give rise to such wide divergences in a substantial number of
cases. On the other hand, it should not be a source of offsetting praise that they
agree about two famous cases.

Figure 1. The Relationship between the Measures of Cukierman, Webb, and

Neyapti [1992] and Alesina [1989]

0.8S
xI

0.6

,...................................................................................

x
z x
g 0.4Lx
.. x 4
X (2 points)
x
x

X (2 points)

...................................................................................

0 -
0 1 2 3 4 5
AIPB

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 Central Bank Independence: Reassessing the Measurements 33

Figure 2. The Relationship between the Measures of Cukierman, Webb, and

Neyapti [1992] and Grinli, Masciandaro, and Tabellini [1991]

0.8

x
..........................................................................................

x . l

z x
B 0.4 x
x

x~~~~
x
x x
x
0.2
x

0 5 10 15 I
GMT

Interpretation

Clearly, the apparent similarity of measures of independence depends on agree-

ment that the central banks of Germany and Switzerland are highly independent. Be-
yond that, the measures are extremely dissimilar. The 0.028 correlation between the
measures of A/PB and CWN for the 15 central banks they both consider, other than
those of these two countries, is an astonishing absence of relationship between two
measures of ostensibly the same thing. This dissimilarity between these measures
has presumably not made itself apparent to date because it is hidden by the similar
ranking of the central banks of Germany and Switzerland.

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 34 James Forder

Figure 3. The Relationship be

Tabellini [1991] and Alesina [1989]

1s

................ . ..---.-. . .. . . . .. . . .. . . .. . . . .. . . . x . .. . . .

x x

10 .x

X (2 points)

x
5 , X X

..........................................................................................

0 1 2 3 4 5
AIPS

It might be thought that I should be more impressed by the similarity of rankings

of the least independent banks as well. That might suggest a hypothesis to the effect
that being at either extreme matters, but being in the middle is compatible with a va-
riety of outcomes. This would suggest thinking in terms of central banks being
either independent or non-independent, possibly with a number of them ranked as
neither and left out of the study. However, this idea is not to the point.
First, I understand the hypothesis these authors are testing to be one about the
whole range of independence. GMT and CWN both use their measures in regres-
sions, and Emerson et al. do the same with A/PB. Alesina is clearly thinking this
way since he refers to the fact that there is, "broadly speaking," the expected rela-
tionship across the whole range of central banks. Second, the ranking of the least in-

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 Central Bank Independence: Reassessing the Measurements 35

dependent is much less uniform. Germany and Switzerland are both strictly the most
independent in two studies, and in the third-GMT-Germany is strictly the most
independent with Switzerland second, equal to the United States. Looking at the
least independent, the story is not the same. In CWN, Norway and Belgium are
equally the least independent. Norway does not appear in GMT, but is just above
the middle in the A/PB ranking (in a large group); Belgium is in the same large
group in A/PB and also in the middle of GMT. Next up the CWN list comes Japan,
which A/PB have toward the other end of the scale, in the second most independent
category, while GMT place it just below the middle. Spain is the fourth least inde-
pendent in CWN and is the first that all the studies agree is non-independent. Look-
ing at those GMT make least independent, we have New Zealand and Portugal first.
New Zealand is agreed to be highly non-independent by CWN and is absent from
A/PB;16 then come Greece, Italy, and Spain again. There is fair agreement about It-
aly being one of the least independent, but Greece is one of the most independent in
CWN, and Portugal is well above halfway. Looking at the A/PB ranking's least in-
dependent central banks results in only one new entry, which is Australia-the
(equal) least independent according to them, but in the middle of the CWN list and
rather independent-sixth out of 18-in GMT.
One can see the difference between the strong agreement over the most inde-
pendent and the very much weaker agreement over the least independent from the
charts: one cannot draw striking "dotted-line rectangles" to exclude the least inde-
pendent in the way one can the most. There is no consistently "south-westerly"
group, but there is certainly a "north-easterly" one.
Whether one feels that these two should be included or excluded, it is clear that,
over the middle majority of central banks, there is no agreement whatsoever as to
what constitutes independence. The conclusion that must be drawn from this is that
on the theoretical side we can discuss degrees of independence, but there is no
agreed empirical correlate of it. These measures are all supposed to be measures of
the same thing, but the thing has not proved measurable.
The importance of this observation is that it points to a serious-indeed, I be-
lieve, fatal-weakness in the empirical case for independence. The failure to agree
on a measure of independence makes impossible any test of the effects of inde-
pendence. It is important to recognize exactly what the point is. It is not the foolish
one that different authors use different approaches to measure independence and so
cannot be said to be talking about the same thing. The problem is not the different
approaches to measurement, but rather the different resultant measures.17
It is easy to see the error of appealing to the similarity results of the comparison
of inflation with "independence" once this distinction is recognized and the impor-
tance of identifying the empirical correlate of the theoretical notion of independence
is noted. 8 It would, for example, be an entirely different matter if different ap-
proaches to the measurement of independence led to similar measures. If study 1

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 36 James Forder

considered criteria A to E, and

the central banks in a similar w
problems of measurement are un
proaches to measurement led to
happened.
It might seem, nevertheless, that since all agree that Germany and Switzerland
have the most independent central banks, and since they also have the lowest infla-
tion, that fact is an agreed empirical finding. This is true in so far as it goes, but
with only two countries under consideration, how confident are we supposed to be
that their low inflation is due to the central bank's status, rather than to some other
factor?19 Why are we supposed to believe that incremental movements towards in-
dependence in other countries will lead to improved performance? No, the claim of
these studies is that they show a general tendency for lower inflation to be associ-
ated with greater independence. And indeed this claim could even be correct, but
what the literature has not succeeded in doing is offering an empirical concept of in-
dependence that allows the claim to be tested.

Conclusions

There is little, if any, disagreement that determining an appropriate measure of

"independence" to test the idea that independent central banks deliver lower infla-
tion is difficult and unavoidably involves arbitrary decisions. Notwithstanding this,
many who have studied the issue, and others who have read their work, have
formed the impression that there are a number of reasonable attempts to measure in-
dependence and they all point in the same direction: independence lowers inflation.
Therefore, they have apparently felt the measurement problems are more apparent
than real.
I have sought to cast doubt on this conclusion from two complementary direc-
tions, each relating directly to the issue of how we should go about measuring inde-
pendence, or-which is a matter of the same underlying issues-how we should go
about assessing different measures. I have pointed out that the apparent uniformity
of results in agreeing that independence lowers inflation depends to some extent on
the results in question being those using the authors' ultimately favored approach to
measurement, but it is difficult to see what earned the approaches in question this
favor other than that they gave the desired result when compared with inflation. The
"test" does not realistically admit falsification. And a large number of such "tests"
are no advance. The essential point is that there do not appear to be any objective
criteria that point in the direction of selecting one measure over another. It is not
that there is a deficiency in the way in which favored measures of independence
have been selected; it is the rather more fundamental one that it is difficult to see

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 Central Bank Independence: Reassessing the Measurements 37

how a satisfactory procedure of selecting measures could be devised. If it cannot,

the currently fashionable measures have nothing going for them.
My second point, I believe, is rather powerful in itself. But it can also be seen as
illustrating the depth of the problem of the first. The point is that, with the excep-
tion of the cases of Germany and Switzerland, the empirical literature to date has
not come to anything resembling a consensus on which banks are independent. This
is, presumably, a symptom of the indeterminacy of how to measure independence.
The importance of this point on its own is that claims to the effect that there exists a
group of studies that show that independence is associated with lower inflation are
most misleading since each member of the group of studies is using a different con-
cept of "independent." Properly understood, the studies are not mutually supportive.
Of course, set beside my first point, the second is a demonstration that the prob-
lem of identifying a good measure of independence has gone unresolved in the lit-
erature: various measures have attracted attention and are widely cited. For
whatever reason, these are measures that are thought to "confirm" the hypothesis.
But in comparing them, we find that quite different-and therefore contradictory
rankings of independence have separately been regarded as "good" rankings of inde-
pendence. This is clearly a mistake.
To repeat the essential point: The nature of "independence" on an empirical
level has not been established. I cannot claim that my arguments have actually dem-
onstrated that it is impossible that the problem will be overcome, but I think that I
have shown first that it has not been overcome, so at present these studies give no
support to the independence hypothesis. Second, I hope I have successfully argued
that the problem of interpreting the statutes is much more significant than has been
supposed: to describe it as difficult and involving arbitrary decisions greatly under-
states the problem-indeed, it mistakes the nature of the fundamental problem. And
third, whatever solution might eventually be advanced, it will require some meth-
odological development of the statute-reading approach as it has been deployed to
date. At present, however, we are back at square one.

Notes

1. There are variations on the precise theoretical grounding of the idea. Parkin and Bade
[1978] emphasize political business cycles of the Nordhaus [1975] kind; Grilli, Mascian-
daro. and Tabellini [1991] think in terms of policy credibility; and Alesina [1988] also re-
fers to the "rational political business cycle" literature, now more developed than at that
time in Alesina and Rosenthal [1995]. My arguments in what follows are not affected by
the precise rationalization since they are concerned with the measurement of inde-
pendence; however, I have argued that basing the case for independence on the idea of
policy credibility is a theoretical error in Forder [1998b].
2. That is in itself controversial. It is argued by Forder [1996] that the statutes should not be
expected to contain the appropriate information. Nevertheless, my objective here is to con-
sider the issue of how, assuming that they do, we can extract it. There is also the question

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38 James Forder

of whether the statutory data have been correctly interpreted. I have questioned one of the
more popular measures in Forder [1998a]. Mangano [19981 has compared the raw data
used in two others and found many contradictions between them, suggesting that one or
both of them need to be recalculated.
3. They also consider non-statutory data, but they construct an index of independence based
solely on statutory data (which they call "legal independence").
4. They go on to express doubts about the causal connection between the two as well as
whether the lowering of inflation is the only consideration in assessing the benefits of inde-
pendence.
5. The Economist magazine, for example, is an influential proponent of this view. A typical
case can be found on page 67 of the March 2, 1996, issue. Artis and Lewis [1993, 571 say
"the issue of an independent Bank resurfaces as one way to supply more credibility. This
is sorely needed." But they offer no evidence either that the credibility is needed or that
independence would supply it. There are many similar examples.
6. In writing about measurement problems, of which a major one is data selection, I am con-
scious that this list of studies is far from all-encompassing. However, I compare studies
with a reasonable number of countries and that, if nothing else, constrains my choice. I
am also aware that some, for example, Banaian, Laney, and Willett [1993], categorized
banks as either "independent" or "not independent," rather than attempting a more con-
tinuous ranking, and this approach may deserve separate attention. If there is a case to be
made that such binary categorization is proof against my critique (which I do not feel there
is), that is a limitation, rather than a refutation, of my point. In any case, I do not believe
that it is controversial that I am considering the best-known and most influential ap-
proaches to the problem. (Alesina and Summers [1993] are well known, but since their
measure is an average of those of Alesina [1988] and Grilli, Masciandaro, and Tabellini
[1991], it is not methodologically separate.)
7. Alesina [1988, 41], being the explanation referred to by Alesina [1989, 81].
8. Indeed, the issue is even more delicate than this since Cukierman et al. treat Portugal and
Greece as less developed although both are OECD and EU members. They both have the
combination of high inflation and (on the Cukierman et al. measure) highly independent
central banks. Greece would have the fourth most independent developed country central
bank after Germany, Switzerland, and Austria, along with the highest rate of inflation.
Again, some reasons can be found to discount these countries from the study, but the same
would apply to many countries. Eliminating the outliers without a clearly convincing rea-
son is not science.
9. We are not lacking them because they are in the literature. But that is incidental-one
could easily (if one were to try) design a measure that would be a plausible representation
of an intuitive notion of "independence" but had little or no relation to inflation, but what
would be the point?
10. Walsh [1993], in a thoughtful review of Cukierman [1992] that presents a very similar
measure of independence to that of Cukierman, Webb, and Neyapti, observes that Cukier-
man seems sometimes to treat the problem as one of identifying the measure of inde-
pendence, rather than testing the hypothesis. But he does not note that the problem is far
more general: it is not Cukierman's implementation of the test that is faulty, it is the test.
11. Suppose the participants in such a blind test intuitively feel that financial independence is
the most important kind, and that leads to the rejection of the hypothesis. That is clearly
not decisive because the intuitions may be wrong. Or they may not. How do we tell?
12. A conclusion that is limited by the existence of the rejected measures, but I leave that
aside here.
13. Again, there is no objectively right way to present this data. Different authors use different
scales, but converting them all to one scale is problematic, not least because the span of
the scales has different interpretations. In Alesina, the most independent central banks are

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 Central Bank Independence: Reassessing the Measurements 39

rated "4," and there is no category "5." In Cukierman et al., the scale goes from 0 to 1,
but all of the sample fall within 0.17 to 0.69. Is 0.69 therefore equal to a 4, or would a
central bank need to score 1.00 to be a "4," or 0.75? I am going to argue that there is a
general lack of association between the measures, and so little, if anything, would be
gained by becoming enmeshed in such problems.
14. Previous authors have pointed out that the measures of independence are not as closely
correlated as one might have hoped. For example, Eijffinger and de Haan [1996, 24-28]
give the issue some attention, but in the end they do not seem to feel the problem is impor-
tant, merely drawing the conclusion that the measures are "incomplete and noisy indica-
tors," rather than that there is a methodological problem.
15. I am computing r2 between the independence rankings of the central banks that are in-
cluded in the two studies under consideration.
16. This is before the Reserve Bank of New Zealand Act of 1989, of course.
17. To highlight my distinction, it might be helpful to think about the measurement of intelli-
gence. It is difficult, it involves arbitrary decisions, and presumably we all implicitly use
different approaches. A minimal, but absolutely necessary, condition of its being a useful
concept is that we all broadly agree about the resultant rankings and not just about the ex-
treme cases.
18. The similarity of the results does owe something to the ranking of Germany and Switzer-
land as the most independent since they are, of course, also the lowest inflation countries.
It is difficult to diagnose the reasons for this similarity in more detail since Alesina says
only that the relationship exists "broadly speaking" and the others are running regressions
including other explanatory variables as well, the inclusion or exclusion of which naturally
raises issues of its own. Barro [1995] actually found no relation between independence and
inflation using a measure almost identical to the CWN one with no other explanatory vari-
ables, although this was on a larger group of countries.
19. This kind of hypothesis, and indeed any one that depends only on a small number of coun-
tries with unusually high or low inflation, is likely also to be more susceptible to the "sub-
conscious bias" problem in designing measures, although blind ranking might overcome
that.

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