Central bank independence and output variability

The benefit of greater central bank independence is the reduction in inflation that should result from the mitigation of a countryʹs time consistency problem. The cost of greater independence is the loss of discretionary monetary policymaking, and consequent increase in output variability. Empirically however, there is no correlation between output variability and central bank independence. A possible explanation for this lack of correlation is that countries which are more likely to have lower output variability are also more likely to choose to have an independent central bank. This hypothesis is tested using data for 44 countries. While the evidence is weakly consistent with this hypothesis, this does not seem sufficient to explain the zero correlation between output variability and central bank independence.