Central bank independence and policy performance: Central-East Europe, 1919--1939 (Austria, Hungary, Czechoslovakia, Poland, Germany, Great Britain)

My thesis examines whether central bank independence from political authority improves economic policy performance. It exploits the results of a natural experiment that was run during the period 1919–1939 in countries of central and east Europe. The Habsburg successor states—Austria, Hungary, and Czechoslovakia—plus the newly resurrected state of Poland set up central banks and issued reconstruction and stabilization bonds to attract foreign capital. The central banks of Austria and Hungary were independent by mandate of the League of Nations; the central banks of Czechoslovakia and Poland were under control of their governments. Politically, Austria and Czechoslovakia were parliamentary democracies; Hungary and Poland were authoritarian. Coming out of the post-war hyperinflation these four countries then confronted the successive periods of economic expansion, crises, and international collapse up to 1939.; I investigate these four countries' policies from theoretical, empirical and historical perspectives. Theoretically, I develop a multi-institutional model to illustrate the relationships of the central bank, the minister of finance and the legislature in the process of setting monetary policy. The model shows that central bank independence can only be credible with adequate political support. Continuity of policy choices and, consequently, financial stability, require that the finance minister or the legislature shares the monetary policy preferences of the central bank. Empirically, I create a data set of weekly bond rates and central bank discount rates for each country, plus Great Britain and Germany, for the period 1922–1939. I use these data to test for the effects of political events and exogenous shocks in each country, to estimate reaction functions of each central bank, and to test for the possibility of contagion during the crisis period. Historically, I rely on primary and secondary sources to describe the design of the four central banks and to uncover the political characteristics of each country.; My results indicate that the domestic political institutions and the historical legacy from the pre-war years were more important than statutory central bank independence for determining policy outcomes.