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Measuring central bank independence for Vietnam

Measuring central bank independence for Vietnam. Recent instabilities in conducting monetary policy in Vietnam’s macroeconomics demand instant preparations for adopting a new framework: Inflation targeting. In fact, the State bank of Vietnam has shown the International Monetary Fund its willingness to adopt this framework over the past 5 years since 2005.



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Journal of Economics and Development, Vol.16, No.1, April 2014, pp. 40-59

ISSN 1859 0020

Measuring Central Bank Independence
for Vietnam
Duong Thi Thuy Nga
Academy of Finance, Vietnam
Email: duongnga.aof@gmail.com
Do Van Vinh
Ministry of Agricultural and Rural Development, Vietnam
Email: dovinh2612@gmail.com

Abstract
Recent instabilities in conducting monetary policy in Vietnam’s macroeconomics demand instant
preparations for adopting a new framework: Inflation targeting. In fact, the State bank of Vietnam
has shown the International Monetary Fund its willingness to adopt this framework over the past
5 years since 2005. In order to prepare for successfully adopting this framework and reaching
price stability, firstly, and most importantly, the central bank needs to have a certain degree of
independence. In fact, the negative relationship between the degree of central bank independence
(CBI) and inflation is found in both industrialised countries and developing countries. In this
study, legal central bank independence indices are calculated for Vietnam according to the newest
and most popular methods of Grilli, Masciandaro, and Tabellini (1991) and Cukierman (1992).
We compare and conclude that the central bank independence index of Vietnam is lower than
that of other emerging countries. In these countries, like Vietnam, the Central bank is a member
of Government. Suggestions for the State bank of Vietnam in terms of improvements in lending
regulations to government, thus, are provided.
Keywords: Central bank independence, inflation targeting, legal institution, monetary policy,
Vietnam.

Journal of Economics and Development

40

Vol. 16, No.1, April 2014

1. Introduction

bel, 2007; Batini and Laxton, 2008; Vega and
Winkelreid, 2005; Corbo et al., 2001; Kuttner
and Posen, 2001) have found improvements to
inherent problems in emerging countries, such
as reductions in the inflation level, in inflation
volatility, and the decline in the persistence
of inflation. Moreover, the practice of IT also
enhances the credibility, accountability, and
transparency of the central bank. These advantages are the reasons for adopting IT in emerging countries.

Several studies have found that in order to
lower the inflation rate, the central bank should
increase the level of independence in relationship to government. Moreover, a high level of
CBI also is the priority requirement for adopting an inflation targeting (IT) framework which
the State bank of Vietnam (SBV) plans to implement in the coming years. This study, thus,
quantifies the degree of CBI. Then, comparisons are made with other countries which have
similarities with Vietnam in economic characteristics and organization of government in
order to evaluate the level of CBI of Vietnam.
Consequently, the study finds the reasons for
the low degree of CBI in this country and for
the recent high inflation rate.

Preconditions play a prominent role in the
literature on IT in emerging countries. Empirically, the IMF (2001) provides certain prerequisites for emerging countries before formal
IT adoption. For instance, (i) independence
of the central bank; (ii) an absence of fiscal
dominance; (iii) a reasonable understanding of
transmission channels between policy instruments and inflation; (iv) a good framework for
forecasting inflation; (v) a well-developed financial system; (vi) a mandate to achieve price
stability; (vii) a reasonable degree of macroeconomic stability; and (viii) transparency
policies to build accountability and credibility.
In practice, Freedman and Otker-Robe (2010)
and De Mello (2008) conclude that central
bank independence (CBI) is one of the most
significant preconditions for adopting successful IT in emerging countries and this needs to
be prepared first. Additionally, several studies
show that the central bank’s independence is
considered to have a link to the inflation rate.
Such studies have been conducted by Eijffinger and Van Keulen (1994), De Haan and Kooi
(2000), Cukierman et al. (2002), and Jacome
and Vazquez (2008). In all cases, there is a negative relationship between the CBI and infla-

Persistent instabilities recently in the inflation rate have posed the question about the ability of the SBV in conducting monetary policy.
In spite of using both indirect instruments such
as money supply, interest rate and administrative and direct intervention, high instability
and persistence still happen, even after a long
time of regional or global crisis. It seems that
the monetary targeting which is followed by
SBV is inappropriate. The bank should start
to prepare for adopting a new monetary policy framework. Indeed, the SBV has shown the
International Monetary Fund (IMF) its willingness to adopt an IT framework into its monetary policy for the 5 years since 2005.
Following the IT framework, the central
bank explicitly commits that the primary goal
is a stable inflation rate around an announced
target. As a result of adopting IT, several studies
(Svensson, 2010; Lin and Ye, 2009; Gonçalves
and Salles, 2008; Mishkin and Schmidt-HebJournal of Economics and Development

41

Vol. 16, No.1, April 2014

different aspects of CBI. Section 3 mentions
the methodologies for measuring CBI. Section
4 demonstrates results and discussion. The conclusion is pointed out in the Section 5.

tion in both industrial countries and developing
countries. The increase in CBI will reduce the
inflation rate. Recently, Daunfeldt, Landstrom
and Rudholm (2013) studied 131 countries
during the 1980-2005 period and found evidence that CBI reforms led to a decrease of
3.31% in countries which experienced a high
inflation rate in the past.

2. Measuring central bank independence:
literature review
Goal CBI vs. instrument CBI
The independence of the central bank is discussed using two main dimensions. The first
one contains institutional characteristics while
the second dimension stresses that the central
bank must be free to use instruments in order to reach the monetary policy goals. Grilli,
Masciandaro, and Tabellini (1991) (hereafter
GMT) called these two dimensions “political
independence” and “economic independence”,
respectively. More commonly, Debelle and
Fischer (1994) introduced these two aspects as
“goal independence” and “instrument independence.”

At the outset of the introduction of IT, the
first focus should be on measuring the independence of the SBV. Different methods for
measuring CBI have been presented. For example, by Bade and Parkin (1988), Alesina
(1988, 1989), Grilli, Masciandaro, and Tabellini (1991), Cukierman, Webb, and Neyapti
(1992) or Cukierman (1992). We introduce
the two most recent methods and focus much
on the method which is more applied by the
author Cukierman (1992). To the best of our
knowledge, there is no study which has calculated a CBI index for Vietnam up to now. In
our study we then compare the calculated indices with those in other emerging countries in
the Asian region that have adopted IT and have
had a long preparation period: Indonesia and
the Philippines. Subsequently, improvements
in the SBV’s independence will be suggested.

Legal CBI vs. actual CBI
According to Cukierman (1992), the degree
of CBI is determined by the nature of political
and legal institutions as well as by less structured factors such as informal arrangements
between the central bank and other parts of
government, the quality of the bank’s research
department, the personalities of key individuals in the bank and other economic policymaking organs. The legal CBI is determined by the
charter of the central bank which mentions the
central bank’s objectives, the procedures for
appointment, along with the Governor tenure,
the monetary instruments and so on. Actual
CBI, as opposed to legal CBI, is obviously hard
to quantify because of the above less formal
factors. Consequently, the existing efforts to
measure the CBI indices mostly focus on legal

These Asian countries have been chosen
also because of the similarities among the
neighbouring countries in terms of economic
characteristics, such as domestic production,
international trade, and foreign capital flows.
Additionally, Indonesia and the Philippines
both changed their policy from monetary targeting to IT in the early 2000s. Moreover, more
stability in the inflation rate has also been obtained since then in these countries.
Section 2 reviews the literature around the
Journal of Economics and Development

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Vol. 16, No.1, April 2014

al. (1992) also demonstrated the two-way causality between inflation and CBI. The lower
independence produces higher future inflation,
and subsequently, in turn, diminishes the actual
level of CBI.

CBI, not actual CBI.
Of course, the aggregation of both legal and
actual indices will give a better view about the
central bank’s independence in a country. Empirically, several studies found a high deviation
between legal central bank independence and
actual independence, especially in developing countries. For instance, Cukierman (2007)
takes the various formal and informal institutional factors into consideration, such as the
type of exchange rate regime, the ability of the
bank to engage effectively in open market operations, and the stance of fiscal policy. Also,
he constructed the CBI indices for Israel. He
pointed out that substantial changes in the actual independence occurred without many changes to the legal independence.

In summary, as common knowledge, legal
CBI is preferable in measuring CBI. Firstly, because only written information from the charters is used, it shows the degree of independence that legislators confer on central bank.
Secondly, it is easier to measure than the actual
CBI method. As a result, the availability of the
legal index is appropriate to compare with previous years and across countries. Thus, in this
study we demonstrate the legal CBI index as
the CBI of Vietnam.
3. Methodology

Taking into consideration the actual CBI,
firstly Cukierman (1992) presented the actual average term of office of the central bank’s
Governor. This indicates that at least above
some threshold, a larger turnover of Governors
demonstrates a lower level of CBI. Another
indicator, secondly identified in Cukierman, is
based on responses to a questionnaire on CBI
by the specialists on monetary policy and institutions within the central bank. The questionnaire contains 9 questions following 5 groups:
(i) legal aspects of CBI; (ii) actual practice
when it differs from the stipulation of the law;
(iii) monetary policy instruments and the agencies controlling them; (iv) intermediate targets
and indicators; and (v) final objectives of monetary policy and their relative importance.

Several authors give different methods
for measuring CBI. Earlier, Bade and Parkin
(1988) calculated CBI based on the political
independence of the central bank. Political independence is expressed by the institutional
relationship between the central bank and the
governments with respect to the formulation of
monetary policy, the procedure to appoint and
to dismiss the Governor, and the financial and
budgetary relationship between central bank
and governments.
Alesina (1988, 1989) added a fourth criterion into Bade and Parkin’s method, namely
whether the central bank is obliged or not to
buy short-term Treasury facilities. Later, GMT
constructed some indices to measure central
bank autonomy in 18 countries of the Organisation for Economic Co-operation and Development (OECD). There is one point for each
answer. The overall degree of central bank independence is determined by a combination of

Nonetheless, in all cases of whether legal or
actual CBI, Cukierman (1992) concluded that
a lower degree of CBI is also associated with
a higher mean level of inflation. Cukierman et
Journal of Economics and Development

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Vol. 16, No.1, April 2014

all political and economic CBI.

the autonomy in the selection of instruments.
The autonomy in choosing the instruments for
monetary policy is evaluated by: (i) the influence of the government in determining how
much to borrow from the central bank; and (ii)
the nature of the monetary instruments under
the control of the central bank. If the government can influence the quantity and the conditions under which it borrows from the central
bank, it also influences the creation of the monetary base and lessens the economic independence of the central bank.

Political autonomy or goal independence is
defined as the ability of the central bank to set
the final objectives of monetary policy. GMT
evaluated the political independence of central
banks using eight criteria. The first four criteria
describe the rules for appointing the Governor
and the Board of the central bank. The political independence of the central bank is clearly higher if the appointments are not under the
control of the government, and with a longer
period.

The first aspect summarizes the government’s ease of access to central bank credit.
The government can have loans: through direct
credit facilities, or through purchasing government securities in the primary market. In the
former, economic independence of the central
bank is greater if direct credit to the government is: non-automatic, at a market interest
rate, explicitly stated as temporary, and limited
in amount. In the latter, the central bank does
not participate in the primary market, since
public debt is considered to have more freedom
from implicit or explicit pressures to lend to the
government.

▪▪ The Governor is appointed without government involvement.
▪▪ The Governor is appointed for more than
five years.
▪▪ The Board of directors is appointed without
government involvement.
▪▪ This Board is appointed for more than five
years.
The fifth and sixth criteria are related to the
relationship between the central bank governing bodies and the government. The political
independence of the central bank is greater if:
There is no mandatory participation of government representatives in the board; and if no
government approval is required in formulating
monetary policy.

The second aspect relates to the nature of
the monetary instruments under the control of
the central bank. If the central bank does not
have control over the discount rate, its ability
to determine the general level of interest rates
is severely weak. Furthermore, a central bank
with no responsibility for overseeing the banking sector or with sharing this responsibility
among other institutions is believed as more
instrument independence. In particular, the
central bank’s independence may be weakened
if administrative instruments such as portfolio

Finally, the central bank’s constitutional position is clearly strengthened if there are
requirements in the charter forcing the central
bank to pursue monetary stability amongst its
primary objectives; and there are legal protections that strengthen the central bank’s position
in the event of a conflict with the government.
The economic independence or instrument
independence of the central bank is shown by
Journal of Economics and Development

44

Vol. 16, No.1, April 2014

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