European Journal of Economic and Financial Research
ISSN: 2501-9430
ISSN-L: 2501-9430
Available on-line at: http://www.oapub.org/soc
Volume 2 │ Issue 1 │ 2017
doi: 10.5281/zenodo.376860
MEASURING CENTRAL BANK INDEPENDENCE IN MALAWI:
THE NEW INDEX OF INSTITUTIONAL QUALITY APPROACH
Frank Kamanga1i, Mtendere Chikonda2
Master’s Degree in Economics Student at Marmara University, Turkey
1
Senior Economist at the Reserve Bank of Malawi
2
Abstract:
This study applied the Index of Institutional Quality (IQ) methodology to measure the
level of independence of the Reserve Bank of Malawi (central bank) and examine its
impact on inflation. The IQ methodology assesses independence of central banks based
on their actual practices. The methodology is suitable for developing countries whose
practices do not fully conform to the laws of Banks that are in place. The study finds
that the average independence index of the Reserve Bank of Malawi (RBM) is 15.1,
which is more than half below the total index value of 36. This clearly shows that the
RBM is not convincingly independent. Although the results show an above-average
value for the index of monetary policy independence, indications are that the RBM is
not free from political pressures as evidenced by below-average values for indices of
political and fiscal independence. Using Ordinary Least Square (OLS), the results
further show that the low degree of independence by the RBM has contributed to high
inflation in Malawi.
Keywords: index of institutional quality methodology, central bank, Reserve Bank of
Malawi, central bank independence, inflation
JEL: E01, E42, G38
1. Introduction
The Reserve Bank of Malawi (RBM) was established in 1964 under the Act of Parliament
which was passed in July 1964 but became operational in 1965. At the time of its
Copyright © The Author(s). All Rights Reserved.
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Frank Kamanga, Mtendere Chikonda
MEASURING CENTRAL BANK INDEPENDENCE IN MALAWI: THE NEW INDEX OF
INSTITUTIONAL QUALITY APPROACH
establishment, RBM’s objectives were limited to issuing legal tender, maintaining
foreign exchange reserves, promoting monetary stability, develop the financial system,
in addition to being a banker to the Malawi Government. The coming of the IMFsupported financial sector liberalization programs in the 1980s led to the enactment of
the RBM Act in 1989. This enactment broadened the mandate and powers of the RBM,
granting it more monetary policy operational independence and more financial sector
supervisory powers that had hitherto been in the hands of the Ministry of Finance, and
led to the abandon of repressive monetary policy toolsii in favour of market-oriented
indirect monetary policy instruments.iii Such a move was aimed at facilitating the
conduct of monetary policy in line with the macroeconomic objectives of a manageable
and stable inflation rate, high economic growth, and a sustainable balance of payments
(BOP) position.
Despite the above reforms, performance of the targeted macroeconomic variables
has generally not been satisfactory over the years. Inflation has at most times been in
double-digits; current account balance in deficits; and the rate of economic growth far
less below the minimum required for poverty reduction and sustainable development.
These outcomes raise a number of questions regarding the conduct and effectiveness of
monetary policy in Malawi and have thus, motivated growing research interest in this
area. So far, the focus has been on validating theories such as exchange rate pass
through (e.g. Jombo et al. 2014) and Structuralist and Monetarist theories (e.g. Simwaka
et al. 2012). As it is known, these theories were developed on the assumption of a
perfect market economy where the role of institutions and government are largely
neglected. However, in recent years a body of political economy literature has shown
that institutional factors such as central bank independence also play an important role
towards the attainment of monetary policy goals, especially the inflation objective. As
classified in Eijffinger and De Haan (1996), a central bank attains independence if
influence of government in the areas of mainly personnel, financial, and policy matters
is excluded or drastically curtailed. Whether such independence is present in the
Reserve Bank of Malawi and its associated impact on inflation is something that this
paper seeks to investigate.
Theory predicts a negative relationship between CBI and inflation and this has
been empirically supported by a number of studies as summarised in Crowe and
Meade (2007), and Cukierman (2008), among others. Such a relationship exists because
it is assumed that independence insulates central bank policymakers from political
These are quantitative tools such as credit ceilings and quotas, interest rate caps, and directed lending to
candidate sectors.
iii Open market operations, Reserve Requirement, and Discount Rate.
ii
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INSTITUTIONAL QUALITY APPROACH
pressures and therefore, enables the Bank to achieve its primary objective of price
stability. However, due to the diversity of the form which CBI takes, to test the CBIinflation hypothesis one needs an indicator that measures the extent to which monetary
policy is independent of political influence. So far, the bulk of empirical literature has
focused on indicators for the legal measure of CBI and the measure for turnover rate of
central bank governors. As Klomp and De Haan (2010) point out, legal measures of CBI
may not reflect the true relationship between the central bank and government
especially in countries where the rule of law is less strongly embedded in the political
culture like the case in most developing countries. There can be wide gaps between the
formal legal institutional arrangements and their practical impact (Walsh, 2005).
Cuikerman et al. (1992) argue that the actual average term in office of the central bank
governor may therefore, be a better proxy for CBI for developing countries than
measures based on central bank laws. However, as indicated in Klomp and De Haan
(2010), this argument is also subject to criticism as sometimes governors may hold office
longer simply by being obedient to political leaders.
A major limitation with the traditional approaches to CBI is that the index has
been derived using one indicator of central bank independence. The problem with this
approach, however, is that the resultant index may not match with the actual practice
and therefore, is suboptimal. As suggested in Cuikerman (2004), a better index would
be one that combines effects of all aspects of central bank independence applicable to an
economy.
In line with Cukierman’s proposition, the current study applies Mathew
’s
institutional quality approach to develop a CBI for the Reserve Bank of Malawi. The
index is derived from combined effects of attributes from Monetary Policy
Independence (MPI); Personnel or Political Independence (PI); and Fiscal or Financial
Independence (FI). As stated by Mathew , the index is better called an actual or de-facto
index rather than a legal or de-jure index because it is based on the actual institutional
practices (norms) of the central bank and not necessarily, what is written in central bank
laws. Hence, the index is an interpretation of CBI based on those laws, which are put to
actual practice and those practices that are not in the law.
The overall objective of this study is therefore, to determine the level of
independence for the Reserve Bank of Malawi and determine its driving factors, as well
as examine whether there exists a relationship between CBI and inflation. The
remainder of the paper is organised as follows: section 2 presents a review of new
institutional economics and central bank independence. Section 3 describes the
methodology, while section 4 examines the measurements and presents the results of
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INSTITUTIONAL QUALITY APPROACH
the econometric analysis. The final section provides concluding comments and policy
recommendations.
2. Central Bank Independence: The New Institutional Economics Framework
The theoretical roots of central bank independence are embedded in the New
Institutional Economics (NIE), which advocates for analysis of the roles of the state and
its agencies, such as central banks, in the market economy. The current study follows
the definition of CBI in Eijffinger and De Haan (1996), which is based on the context of
institutional relationship between government and the central bank. According to
Eijffinger and De Haan, CBI relates to three areas in which the influence of government
must be either excluded or drastically curtailed: (i) independence in personnel, (ii)
financial, and (iii) independence with respect to policy matters.
A central bank is said to have Personnel or Political independence (PI) if the
influence of government is partially or fully excluded from central bank’s appointment
procedures. The level of such independence may be determined by factors such as
government representation in the governing body of the central bank and government
influence in appointment procedures, terms of office, and dismissal of the governing
board of the bank.
Financial Independence or Fiscal Independence (FI) refers to the ability of the central
bank can restrict the government from direct or indirect access to central bank credit.
Direct credit arises when central bank allows monetization of the fiscal deficit, while
indirect credit happens when the central bank participates in the management of
government debt in the primary market. Direct credit also takes the form of securitized
lending when backed by negotiable securities, and non-securitized lending when not
backed by negotiable securities.
Monetary Policy Independence (MPI) refers to the flexibility given to the central
bank in the formulation and execution of monetary policy. Debelle and Fischer (1994)
distinguish between independence with respect to both goals and instruments. A
central bank is considered to have goal independence if it has complete discretion in
setting the ultimate goals of monetary policy such as inflation, unemployment, or
economic growth.
The governance structure of central banks has two major aspects: corporate
governance, and public governance (Oritani 2010). Of these, NIE mainly provides the
theoretical framework to study deeply the public governance aspect of central banks.
Public governance is understood to be an institutional framework where the public
governs the central bank by and through the legislative and executive bodies in a
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INSTITUTIONAL QUALITY APPROACH
country. Under NIE, two principal theories guide the analysis of public governance
under which the issue of central bank independence is discussed: agency theory and
public choice theory. The agency theory mainly discusses issues related to central bank
independence and accountability. The theory argues that central banks which have
multiple principals have no room to implement biased policies as they are accountable
to several principals. By being accountable to several principals, central banks gain
some form of independence in implementing prudent policies and this is reinforced in
the constitution.
Public choice theory is an aspect of public economics that applies economics to
the analysis of the political process and government behavior. This theory considers
government as an assembly of many individuals, branches, and organizations with
different interests and objectives. The central bank, being an organization with a public
mandate, belongs to the government in a broad sense, as do the legislative, executive,
and judicial branches. It acts in interplay with the other governmental bodies within a
country’s governance structure. Under this theory, debate has also centered on
supporting the existence and role of central bank in solving the problem of government
failure and how to strike the right mix of independence and accountability to ensure
that a central performs its functions to best effect.
Nevertheless, the agency theory and public theory underpin four characteristics
of NIE namely: transaction costs, state and property rights, bounded rationality, and the
role of institutions. Beside the public choice theory and the agency theory, in the wake
of Bretton Woods crisis, new institutionalists also developed new theories to prove that
advancement of central bank independence could deliver low inflation. Among these,
the most significant to be discussed is the time-inconsistency problem of monetary
policy. All these theories are analysed in line with the three aspects of CBI.
3. A New Index of Institutional Quality
3.1 Methodology
This paper adopts Mathew
’s new index for central bank independence, the new
index of institutional quality methodology, to derive an index of independence for the
Reserve Bank of Malawi. This methodology is built on three areas of CBI established by
Eijffinger De Haan (1996). The new indexiv of CBI is constructed as sum of the
numerical values assigned to 18 institutional attributes (both in law and in practice) of
There is no non-arbitrary way of aggregating the various criteria or attributes of CBI to a composite
index. The value of the index is subject to interpretation bias, weighting bias, and criteria bias, since, here
some kind of subjectivity is unavoidable.
iv
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MEASURING CENTRAL BANK INDEPENDENCE IN MALAWI: THE NEW INDEX OF
INSTITUTIONAL QUALITY APPROACH
central banks: 6 for Monetary Policy Independence (MPI); 6 for Personnel or Political
Independence (PI); and 6 for Fiscal or Financial Independence (FI). Each of the above 3
aspects take a maximum value of 12, thus yielding a maximum aggregated value of 36
for the new index of CBI. This index can also be called a weighted index of CBI with a
scalev of 0-36, since attributes are weighted unequally. According to Mathew (2012), the
new index is better called an actual or de-facto index rather than a legal or de-jure index
because the aggregated value is based on the actual institutional practices (norms) of
the CBs and not necessarily, what is written in the central bank law. Hence, the index is
an interpretation of CBI based on those laws that are put to actual practice and those
practices that are not in law. The 18 attributes or criteria used for constructing the new
index for CBI and the possible scores attached to sub-groups of each criterion are
defined in detail in Mathew (2012).
This study constructs and compares CBIs for the Reserve Bank of Malawi for the
sub-sample periods 1964- 1989, 1989- 2010 and 2010- 2014 using attributes for the 3
aspects of CBI outlined above. The sub-samples mainly reflect regimes of the
constitution of the Reserve Bank of Malawi. The score assigned to each criterion is
aggregated to obtain the value of CBI. The higher the value assigned to each criterion,
the higher will be the CBI and therefore, the more independent a central bank is with
respect to that aspect. Using Mathew (2012), the categorization and rating of the
indicators of CBI are as follows:
A. Monetary Policy Independence (MPI)
A1. The degree of conservativeness of the central bank or independence in setting effective
objectives
The objective of monetary policy is only price stability or price stability is the
principal and overriding, long run goal of monetary policy (3 points);
The objective of monetary policy includes price stability and other aspects like
financial stability-both exchange rate stability and banking sector stability (2
points);
The objective of monetary policy includes price stability, financial stability and
other conflicting concerns like stimulating economic growth and employment
output stability (1 point);
The objective of monetary policy is directed to stimulate economic growth and
employment with little or no concern for price stability (0 point).
Maximum Score for CBI=36. Monetary Policy Independence (12) + Personnel Independence (12) + Fiscal
Independence (12) =36
v
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A2. The degree of Goal or Target Independence
The central bank alone sets the numerical goals or targets for its objectives such
as exchange rates, monetary aggregates, interest rates or inflation (3 points);
instance, through a policy targets agreement (1.5 points);
The central bank and government jointly set goals or targets for its objectives, for
The government alone sets the targets for the objectives (0 points).
A3. The degree of Instrument Independence
The central bank alone sets the instruments of monetary policy to achieve its
objectives (3 points);
policy (1 point);
The central bank and the government jointly set the instruments of monetary
The government alone decides on setting instruments (0 point).
A4. General policy conflicts
The central bank absolutely prevails over the government in case of policy
conflicts (1 point);
possible protest from the latter (½ point);
The government prevails over the central bank, subject to due process and
The government absolutely prevails over the central bank (0 point).
A5. Exchange Rate Policy Co-ordination
Central bank formulates and implements exchange rate and foreign exchange
policy consistent with objectives of monetary policy, bank’s view prevails over
the government in case of policy inconsistency (1 point);
Central bank formulates and implements exchange rate and foreign exchange
policy on basis of instructions given by the Government, or Government’s view
prevail over (0 point).
A6. Financial Supervision
The banking supervisory function is separated from the central bank and
entrusted to an autonomous government agency so that it will not impinge on
monetary policy (1 point);
government agency (½ point);
The banking supervision is jointly undertaken by the central bank and separate
The function of monetary policy and banking supervision is combined in a single
institution, the central bank (0 point).
Maximum Score for MPI= 12
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B. Political Independence or Personnel Independence (PI)
B1. Appointment of the Governor
The governor ıs appointed by the central bank Board or two different bodies,
which really balance one another, respectively nominate and appoint the
Governor, for instance, the board or ministry of finance nominates and the
legislature appoints (2 points);
The government both nominates and appoints the governor, for instance,
ministry of finance nominates and the cabinet appoints the governor (0 point).
B2. Terms of the Governor
The term is longer than 5 years (2 points);
The term is 4 years (½ point);
The term is 5 years (1 point);
The term is less than 4 years (0 point).
B3. Dismissal of the Governor
The dismissal of the governor is possible only in the case of breach of
qualification, misconduct, or poor performance; the procedures are very
transparent, and within the approval of the legislature (1 point);
The dismissal of the Governor is possible only in the case of breach of
qualification, misconduct, or poor performance, but the procedures are not
transparent, and not with the approval of the legislature (½ point);
Unconditional dismissal of the Governor by the government (0 point).
B4. Appointment of Board Members
Government appoints not more than half the members of the board; or two
different bodies, which really balance one another, respectively nominate and
appoint the board members, for instance, the ministry of finance nominates and
the legislature appoints (3 points);
Government appoints more than half or all the members of the board (0 point).
B5. Term of the Board Members
The term is longer than five years and staggered (2 points);
The term is 4 years and staggered (1/2 point);
The term is 5 years and staggered (1 point);
The term is less than 4 years and staggered (0 point).
B6. The Presence of Government Nominees in the Bank Board
There is no mandatory participation of government representative in the bank
board (2 points);
There is mandatory participation of government representative in the bank
board (0 point).
Maximum score for PI= 12
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C. Fiscal Independence or Financial Independence (FI)
Limitations on CB lending to the Government
C1. Limitations on advances (non-securitized lending)
Central bank advances to the government prohibited (3 points);
amounts (2 points);
Central bank advances permitted, but with strict limits in terms of absolute cash
Central bank advances permitted with loose and accommodative limits (1 point);
No legal limits on central bank advances to the government (0 point).
C2. Limitation on securitized Lending
Central bank advances to the government prohibited (1½ points);
amounts (1 point);
points);
Central bank advances permitted, but with strict limits in terms of absolute cash
Central bank advances permitted with loose and accommodative limits (1½
No legal limits on central bank advances to the government (0 point).
C3. Specification of the limits of CB Lending
Central bank lending defined in absolute currency amounts (1½ points);
Central bank lending defined in shares of government revenue ( 1 point);
Central bank lending defined in shares of government expenditure (0 point).
C4. Maturity of Loans
The maturity of central bank loans cannot exceed 6 months (2 points);
point);
The maturity of central bank loans above 6 months but cannot exceed 1 year (1
No legal limit on the maturity of central bank loans (0 point).
C5. Restrictions on Interest rates
Central bank lends to the government at market interest rate (2 points);
rates (½ point);
Central bank lends to the government at below market interest rates, but positive
Central bank lends to the government at zero interest rates (0 point).
C6. CBs participation in the primary market for Government securities
The central bank is prohibited from buying government securities from the
primary market or if not prohibited from buying government securities from the
primary market is discretionary or voluntary (2 points);
The central bank is an active and involuntary buyer in the primary market for
Government securities (0 point).
Maximum score for FI = 12.
Subsequently, maximum score of CBI = MPI+PI+FI= 36.
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4. Analysis of Results
Table 1 provides a summary of the computation of the CBI index for the Reserve Bank
of Malawi using the above classification for three sub-sample periods covering 19642014. The sub-periods are determined by the regimes of the constitution of the Central
Bank of Malawi. From the results, the average CBI index is at 15.1, which is below half
of the total level of 36 and lower than that of central banks captured in Mathew (2012)
study. The following section will provide an analysis of CBI ındex in different subperiods.
4.1 Interpretation of CBI Index
A. 1964-1989 Period
An evolution of the 3 aspects of CBI shows that during the period 1964-1989 overall CBI
index was 1 and this emanated from personnel independence as both monetary policy
independence and financial independence had scores of zero. Personnel independence
registered a score of 1 because during this period all the governors completed their
tenure of office. About the monetary and financial independence, the results are not
surprising since during this period, in carrying out its mandate which, according to
section 185 of the Constitution of the Laws of Malawi, was to influence money supply,
availability of credit, interest rates and exchange rate in order to promote price stability,
economic growth and a sustainable balance of payments position, the RBM was mainly
influenced by the Ministry of Finance.
Prior to 1989, RBM was subordinated to the Treasury and it mainly performed
roles as a development bank. Therefore, it was not independent in its conduct of
monetary policy, let alone instrument independence. The conduct of monetary policy
was through direct instruments notably credit ceilings and quotas, interest rate caps,
directed lending to candidate sectors, among others. These controls were ostensibly
designed to favour parastatals and the elites who engaged in commercial agriculture.
B. 1989-2010 Period
During the period 1989-2010, the overall CBI index improved to 15.8 from 1.0 registered
in the period 1964-1989. This improvement was mainly due to gains in Monetary Policy
Independence. Specifically, the MPI score improved to 8 out of 12 from zero in the
previous period. After the liberalization of the financial sector and granting of
independence to the RBM, most of its roles improved. For instance, the central bank
adopted the mandate of ensuring price stability and gained instrument independence
such as setting monetary targets. With the support of the International Monetary Fund,
RBM adopted Monetary Targeting Policy framework in 1994.
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INSTITUTIONAL QUALITY APPROACH
As for financial independence, although the score improved from zero in the
previous period to 7.2, there have been fluctuations in the score due to several factors
notably political business cycles with increased central government borrowing from
central bank during the election periods. Secondly, central bank advances to the
government also grow during periods of donor aid freeze, for instance, prior to 1994
elections and between 2001 and 2003 when the Poverty Reduction and Growth Facility
was withdrawn. These developments reflect time inconsistency and business cycle
theories of central bank independence. Besides that, the law allows RBM to finance
budget deficits using the Treasury Bills and ways and means advances, which is
considered as a major shortfall in as far as central bank independence is concerned.
Furthermore, performance of the RBM on Political Independence (PI) was quite
poor during the 1989-2010 period. The PI score wavered between 0 and 1. The score of 1
was obtained when the appointed central bank governor completed his/her tenure of
office. However, the poor score is attributed to the fact that that there was too much
intervention on bank’s managerial issues by the government. This is highlighted both in
legal acts and is also evidenced in practice. For instance, between 1988 and 1995 there
were changes in central bank governors before the end of their terms of office.
C. 2010-2014 Period
In the period 2010-2014, the overall CBI index slightly dropped to 15.3 from 15.8 despite
amendments to the central bank constitution. The drop in the CBI ındex was mainly
attributed to the actual practices rather than the law. From 2010 to 2014, the MPI score
remained unchanged at 8 as in the previous sub-periods. This notwithstanding, over
these years, indications are that RBM lacked independence in implementation of some
other policy issues related to monetary policy. For instance, the RBM’s exchange rate
policy and foreign exchange decisions were formulated and implemented based on
instructions from government. Furthermore, the function of monetary policy and
banking supervision are combined in a single institution, the RBM. This affects decision
in managing price stability and at the same time ensuring financial system stability.
Meanwhile, the performance of RBM on Political independence during the 2010-2014
period followed the same pattern as the 1989-2010 period.
The study shows that RBM does not meet many of the indicators for political
independence provided by the Institutional of Quality index framework as compared to
fiscal independence. The index of fiscal independence however, dropped slightly from
7.1 in the previous period to 6.7 in the 2010-2014 period. This development was mainly
due to increase in government debt from the central bank following the freeze of donor
support.
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Table 1: Measuring CBI and its Various Aspects in Malawi
Years
1964-1989
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
1989-2010
2010
2011
2012
2013
2014
2010-2014
A1
0
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
3
A2
0
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
1.5
A
Monetary Policy
Independence
A3
A4
A5
0
0
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
0.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
.5
0
3
0.5
0
MPI
A6
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
8
B1
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
B2
1
0
0
0
0
0
0
1
1
1
1
1
1
1
1
1
1
1
1
1
1
0
0
0.64
0
0
1
1
1
0.6
B
Personnel
Independence
B3
B4
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
PI
B5
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
B6
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
1
0
0
0
0
0
0
1
1
1
1
1
1
1
1
1
1
1
1
1
1
0
0
0.64
0
0
1
1
1
0.6
C1
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
C2
0
1.5
1.5
1.5
0.5
0.5
0.5
1
1
1
1
1
0.5
0.5
0.5
0.5
0.5
0.5
1
1
1
1
1
0.86
1
1
0.5
0.5
0.5
0.7
C
Fiscal
Independence
C3
C4
0
0
1
2
1
2
1
2
1
2
1
2
1
2
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
FI
C5
0
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
C6
0
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
2
0
8.5
8.5
8.5
7.5
7.5
7.5
7
7
7
7
7
6.5
6.5
6.5
6.5
6.5
6.5
7
7
7
7
7
7.1
7
7
6.5
6.5
6.5
6.7
CBI
1
16.5
16.5
16.5
15.5
15.5
15.5
16
16
16
16
16
15.5
15.5
15.5
15.5
15.5
15.5
16
16
16
15
15
15.8
15
15
15.5
15.5
15.5
15.3
INF
16.10
12.45
11.82
12.62
23.75
22.77
34.65
83.33
37.60
9.14
29.75
44.80
29.58
22.70
14.74
9.58
11.43
15.41
13.97
7.95
8.71
8.42
7.41
21.5
7.41
7.62
21.27
27.28
24.43
17.6
Note: The new index of CBI is constructed as a sum of the numerical values assigned to 18 institutional attributes (both in law and practice) of central banks: 6 for Monetary Policy
independence (MPI); 6 for Personnel or Political independence (PI); and 6 for Fiscal or Financial independence (FI). The score assigned to each criterion is aggregated to obtain the
value of CBI index that takes a scale of 0-36. Higher the value assigned to each criterion, higher will be the CBI. INF is annual rate of inflation.
European Journal of Economic and Financial Research - Volume 2 │ Issue 1 │ 2017
67
Frank Kamanga, Mtendere Chikonda
MEASURING CENTRAL BANK INDEPENDENCE IN MALAWI: THE NEW INDEX OF
INSTITUTIONAL QUALITY APPROACH
4.2
Regression
Analysis
of
Relationship
between
Inflation
Central
Bank
Independence Index
Using macroeconomic data sourced from RBM publications, a bivariate regression
analysis was conducted between CBI index and inflation. Since the study is carried out
from a political economy perspective, we assumed that the anti-inflationary impact of
CBI may vary depending on the configuration of other political, economic, structural,
and institutional features of the setting in which the central bank operates.
Consequently, another regression analysis was run, which considered effects of other
relevant factors such as GDP, money supply and a dummy variable.
Table 7.2: Regression results
Dependent variable
Variable
Coefficient
DINFL
Std. Error
t-Statistic
Prob.
C
29.01763
6.937236
4.182881
0.0003
DNCBI
0.561034
0.583461
0.961563
0.3448
D2F
12.30395
5.908765
2.082321
0.0469
M2
6.07E-11
2.82E-11
2.150298
0.0406
-9.001063
3.091119
-2.911911
0.0071
DGDP
Variable
Value
R Square
0.312801
F statistic
3.072485
Significance Value of F statistics
0.033000
5. Interpretation of Results
DNCBI is a first differenced form of CBI index and it is positively related to inflation
although the relationship is not significant.
D2F is a dummy variable capturing the CBI developments during the period of
liberalisation of the financial sector. The positive relationship means the low level of
CBI registered in Malawi contributes to inflation. This outcome is consistent with the
findings of Cukierman (2008) and Meade and Crowe (2007). The channel through which
this lack of independence contributes to inflation is mainly through contraction of
government advances from RBM and the Bank’s purchase of government Treasury
Bills.
M2 is broad money supply, which as expected, has a positive coefficient,
implying that an increase in money supply creates inflationary pressures.
DGDP is the first difference of real GDP and it shows a negative relationship
with inflation, thereby confirming predictions by endogenous growth theorists and the
classicalists. Malawi is pre-dominantly an agriculture economy, of which maize (the
European Journal of Economic and Financial Research - Volume 2 │ Issue 1 │ 2017
68
Frank Kamanga, Mtendere Chikonda
MEASURING CENTRAL BANK INDEPENDENCE IN MALAWI: THE NEW INDEX OF
INSTITUTIONAL QUALITY APPROACH
country’s staple food) has a significant weight. A growth in real GDP, which entails
high agricultural production, implies low pressures on food prices that lead to a
decrease in inflation. The converse is also true.
6. Conclusion
This study attempted to apply the Index of Institutional Quality methodology to
measure independence of the RBM. This methodology is supported by theories such as
public choice theory, agency theory and time-inconsistency theory under the New
Institutional Economics framework. The theories under NIE framework showed that
the operations of the central bank at times are not in line with principles of monetary
policy independence, political independence and fiscal independence, which in turn
affects attainment of monetary policy objectives. As a policy analysis initiative, the
study attempted to measure independence of the RBM during the period 1964-2014
through which it was found that the degree of independence was very low, as the
average CBI index stood at 15.1 against the total index of 36. Even though the monetary
policy independence was above average, indices for political and fiscal independence
were both below half of the maximum level of the index. The finding of low degree of
independence for RBM confirms early findings by Wessels (2009) who conducted a
comparative analysis of CBI in SADC countries and found that RBM was not worth to
be classified as independent. This notwithstanding, the index of independence
registered a substantial improvement of 15.1 in the liberalization period compared to 1
in the pre-liberalization period.
Further, the study also finds that the low level of RBM independence contributed
to high inflation in Malawi during the studied period. It is assumed that the link
between RBM independence and inflation is through government advances contracted
from RBM and the Bank’s purchases of government Treasury bills. Therefore, this study
confirms that developing countries with low levels of CBI have high inflation.
The following are some of the policy recommendations drawn from this study.
As Malawi is contemplating on transitioning to inflation targeting monetary policy
framework, government financing from the central bank should be minimal and this
should be enshrined in the law. Emerging economies like Turkey also employed the
same strategy and they have succeeded in reducing inflation to single digits since 2003.
The curtailing of advancement of funds to central government will ensure that the RBM
gains both monetary policy and fiscal independence from the government. Secondly,
representation of government officials in the RBM Board of Governors should be
revisited to ensure that there is not political interference.
European Journal of Economic and Financial Research - Volume 2 │ Issue 1 │ 2017
69
Frank Kamanga, Mtendere Chikonda
MEASURING CENTRAL BANK INDEPENDENCE IN MALAWI: THE NEW INDEX OF
INSTITUTIONAL QUALITY APPROACH
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European Journal of Economic and Financial Research - Volume 2 │ Issue 1 │ 2017
70
Frank Kamanga, Mtendere Chikonda
MEASURING CENTRAL BANK INDEPENDENCE IN MALAWI: THE NEW INDEX OF
INSTITUTIONAL QUALITY APPROACH
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