	Introduction

Keeping an economy growing at a rate compatible with the full utilization of resources over the long run in an environment in which price inflation is stable has been an age-old goal for macroeconomic policy. Monetary policy and the institutional arrangements for carrying it out have long been regarded as important to achieving this goal. The Methodology of the Studies

The basic methodology of the academic studies involves the use of linear regression which is a statistical technique that attempts to estimate mathematically how important central bank independence and various parameters of that independence are to such important indicators of economic performance as the rate of inflation, the variability of inflation, the growth rate of output, the variability of the growth rate of output, and real interest rates. To make such computations, the above definitions of central bank independence must be turned into something that can be measured. 2. 3. The literature on central bank independence is extensive. The authors interpret these results to mean that since the degree of central bank independence is negatively related to the average rate of inflation in a statistically significant way, "monetary institutions matter." Contrary to the conclusion of the authors, the results for 1970-1979 and 1980-1989 suggest that the inflation performance of these countries is not so much related to the policy goal and methods of choosing CB governors and their terms of office (their measure of political independence) as it is to the requirement that the CB not be used to finance the government's budget deficit, their measure of economic independence. Or both? This is the opposite usage from the other indices in this report. The authors are quick to point out, however, that the results are consistent with the view that greater central bank independence may have resulted in a less activist monetary policy and, because of that, a better output-inflation tradeoff. Thus, the evidence for industrial countries supports a highly selective use of the term "central bank independence." Legitimate questions have been raised about the way these studies have been conducted that casts doubts on their findings. For example, Posen theorizes that what matters most in achieving low inflation is effective support by an important constituency, such as the financial sector. The weighting of the various characteristics will also be important in the regression results. Much of the evidence is tainted because it is obtained from an analysis that commingles data from fixed and flexible exchange rate periods. It should also be noted that central bank independence changes over time in ways that some of the studies may not capture. The Relevance of the Empirical Evidence to the Congressional Oversight of Monetary Policy

Much has been made of the empirical finding that central bank independence is negatively associated with the rate of inflation and that this comes as a "free lunch" in terms of no adverse effects on some very important and desirable performance characteristics of an economy. As used in the literature, the phrase applies to three aspects of independence:
1. the degree to which the CB's governing board is isolated from the political process;
2. the degree to which central banks can refuse to monetize public debt, i.e., finance the government;
3. the degree to which price stability has a primacy as the ultimate goal of central bank activity. It cannot directly purchase new Treasury issues. It may, they argue, wish to replace the current multi-goal directive with one directing the Federal Reserve to achieve and maintain price level stability, characteristic (3).
Keeping an economy growing over the long run at rates sufficient to provide full employment for labor and capital with low inflation or a stable price level has been an important goal for economic policy. Money and monetary policy have figured importantly in achieving this goal. Currently, it is argued, central bank independence is important to achieving this end.
Many small factors contribute to central bank independence, and so the literature does not yield a consistent definition of it. Rather, the emphasis is on three aspects of independence, the degree to which
(1) the governing board of the central bank is isolated from the political process;
(2) central banks can refuse to finance government budget deficits; and
(3) price stability has primacy as the ultimate goal of central bank activity.
Various indices of central bank independence have been compiled and used in empirical work to see how closely independence is related to such important performance characteristics of an economy as the rate of inflation, the growth of output, investment, and real interest rates.
For industrial countries, central bank independence indices embodying definitions (2) and (3) appear to be closely related to low inflation and low variability of inflation without having any effect on output and its variability, investment, and real interest rates. In particular, factor (2) seems to be driving the results, and the various measures of factor (1) have a negligible effect, a finding that the authors tend to neglect. Since the Federal Reserve cannot directly finance the U.S. government, factor (2) is not an issue for Congress. However, the results obtained with an index embodying (3) are of relevance to the conduct of monetary policy in the United States. These results may be used to support efforts to redefine the objective of monetary policy to focus it exclusively on price stability.
Critics of these studies point to three major methodological problems and one empirical problem. First, causation may be opposite to that posited. The desire for economic stability, for example, may lead to independent central banks. Thus, causation should run the other way around (or it may run in both directions). Second, central bank independence may arise because an important and influential constituency in a democratic society favors low inflation. Thus, the ultimate reason why inflation is low in some countries is the strength of important constituencies who favor low inflation. And these studies fail to measure this pressure. In a sense, they have captured only the proximate reason for low inflation, not the ultimate reason. Third, questions have been raised about the way that the authors transform non-numeric characteristics of independence into quantitative results. Finally, the data on which some of these empirical estimates are based are tainted in the sense that the samples commingle observations from the fixed and flexible exchange rate periods. The performance of central banks is quite different in each regime regardless of how its stated objective reads. This report will be updated periodically.