Central Banks as Development Actors: Rethinking Independence in Low-Income Economies

Abstract

The conventional wisdom that central bank independence (CBI) is associated with price stability and development, based on the experiences of rich countries, is challenged in the context of low-income developing countries. Although inflation rates decrease with an increase in central bank independence in theory, the levels of development remain flat with the increase in central bank independence in practice. This paper attempts to examine the impact of central bank independence on development in terms of inflation, growth, unemployment, and poverty in the context of 25 low-income developing countries from 2010-2024. The findings of the paper, based on the random effects panel method, reveal that the level of central bank independence is not statistically significant in the context of inflation (coefficient =-12.59, p > 0.05) and growth (coefficient= -2.92, p > 0.05); however, the level of central bank independence is found to have a positive and statistically significant impact on poverty (coefficient 8.11, p < 0.05). This indicates that the formal aspect of independence in law does not capture essential developmental goals and, in fact, could even distract from them. On the other hand, actual independence, or practice, in the form of effective and stable governors, does have a significant effect in reducing inflation (coefficient = -3.89, p < 0.05) and increasing growth (coefficient = 2.22, p < 0.05), emphasizing that actual practice matters more than formal independence. Neither form of independence, in fact, reveals any significant direct effect on unemployment. Openness, on the other hand, does have positive effects on both inflation and growth, implying that price movements are transmitted and that openness is beneficial for growth. Institutional quality, once again, remains insignificant in all the estimations, suggesting that the effectiveness of institutions in these countries still remains at levels too low to directly impact their development. The paper concludes the conventional CBI paradigm needs to be reframed in the context of low-income countries. The ability of an independent central bank to stabilize an economy seems to be attainable only in conjunction with development strategy that includes effective job and poverty reduction goals. The argument of the study is that policymakers in low-income economies should focus their efforts on the achievement of true operational independence of the central banks by strengthening the protections of the central bank governors and the establishment of transparent systems of accountability. On the other hand, the study recommends the extension of the objectives of the central banks to embrace developmental objectives and the improvement of coordination between the central banks and the government to ensure the achievement of price stability.