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«DETERMINANTS OF CENTRAL BANK INDEPENDENCE IN DEVELOPING COUNTRIES: A TWO-LEVEL THEORY by Ana Carolina Garriga BA, International Relations, ...»

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DETERMINANTS OF CENTRAL BANK INDEPENDENCE

IN DEVELOPING COUNTRIES: A TWO-LEVEL THEORY

by

Ana Carolina Garriga

BA, International Relations, Universidad Católica de Córdoba, 1996

MA, Law of the European Union, Universidad Complutense de Madrid, 1999

Submitted to the Graduate Faculty of

the College of Arts and Sciences in partial fulfillment

of the requirements for the degree of

Doctor of Philosophy

University of Pittsburgh

UNIVERSITY OF PITTSBURGH

COLLEGE OF ARTS AND SCIENCES

This dissertation was presented by Ana Carolina Garriga It was defended on May 25, 2010 and approved by Dissertation Co-Advisor: Barry Ames, Professor, University of Pittsburgh Dissertation Co-Advisor: David H. Bearce, Associate Professor, University of Pittsburgh George A. Krause, Professor, University of Pittsburgh Mark Hallerberg, Professor, Hertie School of Governance ii Copyright © by Ana Carolina Garriga iii

DETERMINANTS OF CENTRAL BANK INDEPENDENCE

IN DEVELOPING COUNTRIES: A TWO-LEVEL THEORY

Ana Carolina Garriga, PhD University of Pittsburgh, 2010 This dissertation answers the following question: What are the determinants of central bank independence (CBI) in developing countries? I argue that in developing countries CBI is the product of vulnerable governments trying to attract foreign investors and creditors.

Incumbents‘ vulnerability increases when they experience need for capital. I define need for capital as the presence of growth problems, coupled with losses of FDI or high levels of foreign debt. Countries needing capital have to either attract investment or borrow funds in the international market. Because developing countries cannot rely on their reputation to attract capital, they need to signal their commitment to stable economic policy. I argue that CBI is one of the principal signals that international investors and lenders ask for. Therefore, I expect that as the need for capital increases, developing countries will accommodate the demands of international actors. This occurs independently of the preferences of domestic actors. However, the capacity of a government to respond to international incentives and pressures through CBI is determined by an institutional context that makes institutional change more or less costly. Focusing on presidential systems, I

expect that two factors condition the elasticity of governments‘ responses to international incentives:

the capacity of the actors in the inter-institutional bargaining (president and congress), and the preference distance between the two branches of government.

I present evidence suggesting that need for capital has the opposite effect in developed and developing countries‘ changes in CBI. Developing countries respond to need for capital with CBI

–  –  –

with regard to the domestic level of the theory are mixed: although presidential powers, congress capabilities and preference distance affect the likelihood of central bank reform, they do not affect it in the direction that was expected by the theory. Finally, the case studies provide a closer look at the process of central bank reform in Argentina and Brazil. An analysis of the reforms affecting CBI, and of instances of lack of reform, provides qualitative evidence of incumbents‘ motivations for and obstacles against central bank reform.

–  –  –

ACKNOWLEDGEMENTS

LIST OF ABREVIATIONS

1.0 INTRODUCTION

1.1 DEFINITION AND PUZZLE

1.2 THE ARGUMENT IN BRIEF

1.3 THEORETICAL AND EMPIRICAL CONTRIBUTION

1.4 PLAN OF THE DISSERTATION

2.0 WHAT DO WE ALREADY KNOW ABOUT CBI?

2.1 INTRODUCTION

2.2 EXISTING LITERATURE

2.2.1 Macroeconomic explanations

2.2.2 Explanations from political economy

2.2.2.1 Political instability

2.2.2.2 Government debt

2.2.2.3 Veto players

2.2.2.4 Sectoral interests

2.2.2.5 Partisanship

2.2.2.6 Transparency

2.2.2.7 Informational asymmetries and intraparty conflict

–  –  –

2.2.4 Models of political delegation

2.2.5 Diffusion: Learning and emulation

3.0 A TWO-LEVEL THEORY OF THE DETERMINANTS OF CBI

3.1 INTRODUCTION

3.1.1 Research question

3.2 THEORY

3.2.1 Intuition

3.2.2 Building blocks

3.2.2.1 Problems in the economy and incumbent vulnerability

3.2.2.2 Sources of capital for vulnerable incumbents

3.2.3 Basic story

Level 1. International incentives

3.2.4 3.2.4.1 An international audience

–  –  –

investors

3.2.4.3 The supply: Developing countries needing capital

3.2.4.4 Credibility of the signal

–  –  –

3.2.5.1 Limits of the explanation

3.2.5.2 Particularities of presidential systems

3.2.5.3 Variation across presidential systems

3.2.5.4 Variation within presidential systems





3.2.5.5 Other domestic incentives

–  –  –

3.2.6.1 Inflation

3.2.6.2 Tying hands

3.2.6.3 Diffusion: Learning and emulation

3.3 FINAL REMARKS

4.0 INTERNATIONAL DETERMINANTS OF CENTRAL BANK INDEPENDENCE

4.1 INTRODUCTION

4.2 EMPIRICAL EVIDENCE

4.2.1 Baseline model and description of variables

4.2.1.1 Sample and unit of analysis

4.2.2 Statistical analysis

4.2.3 The baseline model for developed and developing countries

–  –  –

countries

4.2.4 CBI in developing countries

4.2.4.1 Hypothesis 1: Growth problems in developing countries............... 103

–  –  –

4.2.4.5 Control variables

4.2.5 Analyses on different samples

4.2.6 Evaluating the predictions of the models

4.2.7 A note on endogeneity

–  –  –

5.0 DOMESTIC DETERMINANTS OF CENTRAL BANK INDEPENDENCE........ 144

5.1 INTRODUCTION

5.2 EMPIRICAL EVIDENCE

5.2.1 Baseline model and description of variables

5.2.2 Statistical analysis

5.2.2.1 A word of caution on the interpretation of results

–  –  –

5.2.3.1 Need for capital in the baseline model

5.2.4 Hypothesis 6: Presidential powers

5.2.5 Hypothesis 7: Congress capacity

5.2.6 Hypothesis 8: Preference distance

5.2.7 Hypothesis 9: Preference distance and congress capacity

5.2.8 Evaluating the predictions of the models

5.3 INTERPRETATION OF RESULTS

5.4 FINAL REMARKS

6.0 CASE STUDIES

6.1 INTRODUCTION

6.2 ARGENTINA: INTERNATIONAL DETERMINANTS OF CBI AT WORK 189 6.2.1 Central banking in Argentina

6.2.1.1 The Central Bank of the Argentine Republic (BCRA)

6.2.1.2 The nationalization of the Central Bank

6.2.1.3 Decades of instability and the Central Bank

6.2.1.4 The 1992 reform

–  –  –

6.2.2 Explaining the evolution of Argentine central banking

6.3 BRAZIL: HOW MUCH OF AN OUTLIER?

6.3.1 Central banking in Brazil

6.3.1.1 The Bank of Brazil

–  –  –

National Treasury

6.3.1.3 The Brazilian Central Bank (BCB)

6.3.2 Explaining the evolution of Brazilian central banking

6.4 FINAL REMARKS

7.0 CONCLUSIONS

7.1 OVERVIEW OF THE ARGUMENT AND EMPIRICAL FINDINGS............ 233 7.1.1 Summary of the argument

7.1.2 Observable implications

7.1.3 Overview of empirical evidence

7.2 LIMITATIONS OF THE ARGUMENT

7.3 IMPLICATIONS OF THE FINDINGS

7.4 PATHS FOR FUTURE RESEARCH

APPENDIX A

BIBLIOGRAPHY

–  –  –

Table 2.1.

Political economy explanations of CBI: Selected variables, operationalization and results

Table 3.1.

Summary of hypotheses

Table 4.1.

Summary of hypotheses. International determinants of CBI

Table 4.2.

Summary of hypotheses, independent variables, and expectations

Table 4.3.

Descriptive statistics (full sample)

Table 4.4.

Determinants of CBI change for developed and developing countries

Table 4.5.

Descriptive statistics (developing countries)

Table 4.6.

Determinants of CBI change for developing countries

Table 4.7.

Effect of Growth on CBI change in developing countries

Table 4.8.

Effect of Growth on CBI change in developing countries: Coefficient for Growth at different levels of FDI/GDP change and Debt

Table 4.9.

Effect of Growth deviation on CBI change in developing countries: Coefficient for Growth deviation at different levels of FDI/GDP change and Debt

Tables 4.10.

Number of observations, central bank reforms, and reforms increasing CBI at different levels of Growth, FDI/GDP change and Debt (Developing countries, 1972-2008)

Table 4.11.

Effect of previous level of CBI on CBI change

Table 4.12.

Effect of regime on CBI change

–  –  –

Table 4.14.

Effect of CBI change on Growth

Table 5.1.

Summary of hypotheses. Domestic institutional hurdles

Table 5.2.

Summary of hypotheses, independent variables, and expectations

Table 5.3.

Descriptive statistics

Table 5.4.

Political variables‘ descriptive statistics

Table 5.5.

Domestic determinants of central bank reform. Baseline model selection

Table 5.6.

Domestic determinants of central bank reform. Different controls

Table 5.7.

Domestic determinants of central bank reform. Samples split on capital need

Table 5.8.

Domestic determinants of central bank reform. Additional controls for Presidential powers 164 Table 5.9. Domestic determinants of central bank reform. Presidential powers and Opposition share........ 167 Table 5.10. Domestic determinants of central bank reform. Effects of Congress capacity

Table 5.11.

Descriptive statistics for Presidential powers in years of central bank reform

Table 6.1.

Argentine authorities

Table 6.2.

Brazilian authorities

Table 6.3.

Economic indicators – Brazil 1960-2008

–  –  –

Figure 1.1.

Main determinants of CBI

Figure 4.1.

Number of countries by 2007 CBI score, in.05 increases

Figure 4.2.

Change in CBI: Comparison of FDI/GDP change coefficients conditional on levels of Growth

Figure 4.3.

Change in CBI: Comparison of Debt coefficients conditional on levels of Growth............97 Figures 4.4 (a & b).

Change in CBI: Impact of FDI/GDP change and Debt (IMF use) conditional on levels of Growth

Figure 4.5.

Change in CBI: Impact of CBIt-1 conditional on levels of CBIt-1

Figure 4.6.

Change in CBI: Coefficient of Growth at different levels of Democracy

Figures 4.7 (a & b).

Change in CBI: Coefficient of FDI/GDP change and Debt (IMF use) at different levels of Democracy

Figure 4.8.

Predicted CBI change and actual CBI changes

Figure 5.1.

Central bank reform: Coefficient associated to Opposition share, conditional on Congress capacity

Figure 5.2.

Central bank reform: Coefficient associated to Presidential powers, conditional on Opposition share

Figure 5.3.

Central bank reform: Coefficient associated to Congress capacity, conditional on Opposition share

–  –  –

Figure 5.5.

Central bank reform: Coefficient associated to Opposition share, conditional on Congress capacity

Figure 5.6.

Central bank reform: Coefficient associated to Polarization, conditional on Congress capacity

Figure 5.7.

Probability of reform increasing CBI and actual reforms

Figure 6.1.

International determinants of CBI in Argentina, 1960–2008

Figure 6.2.

Probability of central bank reform increasing CBI and actual central bank reforms..... 205 Figure 6.3. Determinants of CBI in Brazil, according to Maxfield 1969–2000

Figure 6.4.

Determinants of CBI in Brazil, according to Saddi 1960–2008

Figure 6.5.

International determinants of CBI in Brazil, 1960–2008

Figure 6.6.

Probability of central bank reform increasing CBI and actual central bank reforms..... 227

–  –  –

I would never have been able to complete my dissertation without the guidance of my committee members, help from friends, and support from my parents and husband.



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