Down, Ian. (2004). "Central Bank Independence, Disinflations, and the Sacrifice Ratio". Comparative Political Studies, 37(4), 399-434. http://cps.sagepub.com/cgi/content/abstract/37/4/399
This study looks at CBI and the phenomena of disinflation to see if there are any costs to having an independent central bank that controls for inflation strictly. It had typically been seen that CBI controlling for inflation was a “free lunch”, and that there were no adverse economic costs. However, this study attempts to show that there are costs associated with CBI controlling for inflation, specifically in the realm of disinflation.
Disinflations are, “policy-induced reductions in inflation” (400). Down claims that, “the economic contraction that tends to accompany a disinflation appears to be more severe when a central bank is politically autonomous” (400). These periods of policy induced economic reverse can be associated with negative effects on societal welfare, increased unemployment, slow or negative economic growth and other explicitly distributional effects.
Down also deploys the sacrifice ratio, which measures, “the cost, in terms of either output or unemployment, of a point reduction in inflation. It thus measures the relative cost of a reduction in inflation: the higher the ratio, the greater the relative cost” (401). Down concludes that, “CBI is positively associated with the sacrifice ratio,” and that, “political and institutional factors play an important part in determining the costs of disinflations, particularly the unemployment costs” (401).
He finds that the inflation-output sacrifice ratio is highly and positively correlated to CBI disinflationary policies. More gradual disinflation is also more highly correlated to the sacrifice ratio. However, while there is a relationship, there is also no clear and universal relationship between either the inflation-output or the inflation-unemployment sacrifice ratios and Down claims that both must be investigated in more detail.
He then deploys a quantitative method for measuring the relationship between sacrifice ratios and disinflation. He creates four models and uses an OLS regression. He concludes that, “…the most striking result to emerge from the analyses is the robust positive relationship between CBI and the unemployment and output costs of disinflations” (430). “In sum, the relative inflation aversion of policy makers appears to increase the costs they are iwlling to impose on society to reduce inflation” (430). “Put simply, althought CBI may generate long-run gains for the economy, it does appear to be associated with greater short-run costs. This in turn suggests that CBI may not offer the unequivocal free lunch many believe accompanies greater independence” (432).
