Checks and balances, and the supply of central bank independence

The paper analyzes the institutional conditions under which policymakers can credibly commit to an independent central bank and thereby mitigate the well-known time consistency problem in monetary policy. It is shown theoretically that granting independence via a statute is only credible for legislative systems with at least two heterogeneous decision-making bodies which both have veto rights (for example bicameral systems). This thesis is supported by empirical evidence: The legal independence of central banks is significantly higher in those OECD countries whose legislative processes are characterized by extensive checks and balances. Furthermore, the negative relation between legal independence and inflation is larger in countries with checks and balances than in countries without checks and balances. (C) 1999 Elsevier Science B.V. All rights reserved. JEL classification: D72; E58.