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DETERMINANTS of CENTRAL BANK INDEPENDENCE in DEVELOPING COUNTRIES: a TWO-LEVEL THEORY by Ana Carolina Garriga BA, Internationa

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DETERMINANTS of CENTRAL BANK INDEPENDENCE in DEVELOPING COUNTRIES: a TWO-LEVEL THEORY by Ana Carolina Garriga BA, Internationa 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 2010 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 2010 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 iv increases. Changes in CBI are also affected by the expected credibility of the signal. The findings 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. v TABLE OF CONTENTS ACKNOWLEDGEMENTS .................................................................................................. XV LIST OF ABREVIATIONS .............................................................................................. XVIII 1.0 INTRODUCTION ........................................................................................................... 1 1.1 DEFINITION AND PUZZLE ............................................................................... 2 1.2 THE ARGUMENT IN BRIEF ............................................................................... 3 1.3 THEORETICAL AND EMPIRICAL CONTRIBUTION .................................... 5 1.4 PLAN OF THE DISSERTATION ......................................................................... 7 2.0 WHAT DO WE ALREADY KNOW ABOUT CBI? ........................................................ 9 2.1 INTRODUCTION .................................................................................................. 9 2.2 EXISTING LITERATURE ................................................................................... 10 2.2.1 Macroeconomic explanations ..................................................................... 11 2.2.2 Explanations from political economy ......................................................... 14 2.2.2.1 Political instability ............................................................................. 14 2.2.2.2 Government debt ............................................................................... 15 2.2.2.3 Veto players ....................................................................................... 16 2.2.2.4 Sectoral interests ................................................................................ 17 2.2.2.5 Partisanship ....................................................................................... 17 2.2.2.6 Transparency ..................................................................................... 18 2.2.2.7 Informational asymmetries and intraparty conflict .......................... 18 vi 2.2.3 International political economy .................................................................. 21 2.2.4 Models of political delegation ..................................................................... 24 2.2.5 Diffusion: Learning and emulation ............................................................. 25 3.0 A TWO-LEVEL THEORY OF THE DETERMINANTS OF CBI ............................. 27 3.1 INTRODUCTION ................................................................................................ 27 3.1.1 Research question ....................................................................................... 28 3.2 THEORY ............................................................................................................... 29 3.2.1 Intuition ....................................................................................................... 29 3.2.2 Building blocks ........................................................................................... 31 3.2.2.1 Problems in the economy and incumbent vulnerability ................... 31 3.2.2.2 Sources of capital for vulnerable incumbents ................................... 35 3.2.3 Basic story ................................................................................................... 41 3.2.4 Level 1. International incentives ................................................................ 43 3.2.4.1 An international audience .................................................................. 43 3.2.4.2 The demand for developing countries: International creditors and investors ........................................................................................................... 46 3.2.4.3 The supply: Developing countries needing capital .......................... 54 3.2.4.4 Credibility of the signal ..................................................................... 58 3.2.5 Level 2. Domestic hurdles: Central bank reform in presidential systems 63 3.2.5.1 Limits of the explanation ................................................................... 63 3.2.5.2 Particularities of presidential systems ............................................... 67 3.2.5.3 Variation across presidential systems ............................................... 68 3.2.5.4 Variation within presidential systems ............................................... 71 3.2.5.5 Other domestic incentives ................................................................. 74 vii 3.2.6 Alternative hypotheses ................................................................................ 76 3.2.6.1 Inflation .............................................................................................. 76 3.2.6.2 Tying hands ....................................................................................... 76 3.2.6.3 Diffusion: Learning and emulation ................................................... 77 3.3 FINAL REMARKS ................................................................................................ 78 4.0 INTERNATIONAL DETERMINANTS OF CENTRAL BANK INDEPENDENCE ......................................................................................................................................... 79 4.1 INTRODUCTION ................................................................................................ 79 4.2 EMPIRICAL EVIDENCE .................................................................................... 81 4.2.1 Baseline model and description of variables .............................................. 81 4.2.1.1 Sample and unit of analysis ................................................................ 86 4.2.2 Statistical analysis ........................................................................................ 89 4.2.3 The baseline model for developed and developing countries .................... 89 4.2.3.1 Remarks on the baseline model for developed and developing countries .......................................................................................................... 99 4.2.4 CBI in developing countries ....................................................................
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