Independence day for the 'Old Lady': A natura experiment on the implications of central bank independence

Central bank independence is widely thought be a sine qua non of a

credible commitment to price stability. The surprise decision by the UK

government to grant operational independence to the Bank of England in

1997 affords us a natural experiment with which to gauge the impact on

the yield curve from the adoption of central bank independence. We

document the extent to which the decision to grant independence was

‘news’ and illustrate that the reduction in medium- and long-term

nominal interest rates was some 50 basis points, which we show to be

consistent with a sharp increase in policy-maker’s aversion to inflation

deviations from target. We therefore suggest that central bank independence

represents one of the clearest signals available to elected politicians

about their preferences on the control of inflation.