Degree Of Central Bank Independence Research Articles

Central Bank Independence and Inflation Under Asymmetric Information: Delegation vs. Seesaw Effects

Abstract Recent empirical research finds little or mixed evidence in favour of a negative relationship between central bank independence and inflation. In this paper, we construct a theory where the relationship between inflation and central bank independence depends on the extent of informational asymmetry regarding the government’s efficiency in its provision of public goods and also provide some empirical support for it. In the theoretical part of the paper, we introduce the degree of central bank independence as a fixed cost that is paid when the government (whose objective is to minimize output gap via inflation or costly fiscal expansion) rejects the monetary policy proposal of the central bank (which aims to minimize inflation) and determines both fiscal and monetary policies itself. Government efficiency in providing public goods, i.e. the cost of fiscal expansion, is the private information and the source of informational asymmetry in our model. In this setting, increasing the fixed cost of rejecting the central bank’s offer creates two opposite effects on inflation: delegation effect and seesaw effect (since fiscal and monetary expansion are substitutes for the government, now it relies more on fiscal expansion). We show that while the magnitude of the delegation effect is equal to or higher than the seesaw effect, the magnitude of each effect depends on the current level of the fixed cost. If the current fixed cost is not high enough, then a small improvement in central bank independence creates a relatively smaller delegation effect compared to the case where fixed cost is high enough and both efficient and inefficient government types accept the offer.

THE IMPACT OF MONETARY POLICY ON GREEN INNOVATION: GLOBAL EVIDENCE

This research investigates and robustly verifies the impact of expansionary monetary policy actions on green innovation, conducted on a panel covering 133 countries from 1960 to 2018. Overall, we find that such actions have a significantly positive effect on green innovation performance, no matter in the static or dynamic model. A lower degree of central bank independence and poorer property rights protection in developing countries may hinder monetary policies’ effect to be transmitted to green innovation activities smoothly. Moreover, stringent environmental regulation contributes to magnifying the expansionary monetary policy’s positive effect on green innovation, but such a positive moderating effect should be supported by good national governance quality (including better control over corruption, higher efficiency of governments and a complete law system). Accordingly, several policy suggestions are provided.

Revisiting the inflation-hedging properties of precious metals in Africa

Recent work has suggested that precious metals can be used as inflation hedges in several African nations. A closer examination of the data suggests there is little merit to using precious metals for this purpose. While consumer prices, platinum prices, and (potentially) the exchange rate may be threshold cointegrated in Ghana, Morocco, and Tanzania, whether platinum can be used as a respite from an inflation shock depends on the regime in which the shock occurs. Independently of the degree of central bank independence and the inflation targeting regime, the search for a suitable inflation hedge in many African nations continues.

Signaling effect of fiscal reforms during political uncertainty: A game theory approach

This paper examines how rules and institutions and monetary-fiscal coordination setup impact welfare outcomes during political instability. Our theoretical model extends the analysis of Alesina and Tabellini (1987), Alesina and Gatti (1995), and Ferre and Manzano (2014) to examine the signaling content of the fiscal authority’s decision to engage in a fiscal reform when the policymaker’s preferences are private information. In a two-stage signaling game featuring a central banker, a government, and private agents, we examine the fiscal authority’s decision to engage in a fiscal reform under a Nash game, a cooperative setup, and a model of Stackelberg leadership. Three main results: 1) rules and commitments contribute to decreasing time inconsistency; 2) the more control the fiscal authority has over monetary policy, the more undesirable welfare outcomes, especially during political instability; 3) central bank independence signals fiscal discipline and produces relatively more desired outcomes during times of political uncertainty. Nevertheless, even with low degrees of central bank independence, proper fiscal “rules” produce close outcomes of an independent central bank even under the dominance of a centralized political authority and can secure close welfare gains in terms of inflation and fiscal outcomes. We propose these theoretical findings for empirical examination in emerging countries with prevailing schemes of fiscal dominance and more dependence on discretionary interventions to secure growth rates and financing gaps. Such setups are argued to contribute to lowering welfare outcomes that could be reduced if proper fiscal rules were used as a substitute for low monetary independence.

Earthquakes and Economic Outcomes: Does Central Bank Independence Matter?

This study explores whether the degree of central bank independence influences the economic performance in the period immediately following an earthquake. Earthquakes create a classic monetary policy challenge: how to accommodate the real shock in the short run with the objective of low inflation. The ultimate outcome of this dilemma depends for a large part on the degree of delegation of the monetary powers to an independent central bank and the inflation averseness of the central bank governors. Our main empirical findings clearly indicate that the increase in the inflation rate after an earthquake is significantly smaller when monetary policy is conducted by a more independent central bank. At the same time, countries with an independent central bank are confronted with a wider output gap after an earthquake suggesting a slower economic recovery.

What drives the duration of credit booms?

AbstractThis paper presents a new perspective on the study of credit booms by both examining what determines their duration and testing for relevant political features. The results from the estimation of a discrete‐time duration model show that both the economic and the political environment influence the duration of credit booms. These events are found to last longer when: (a) the economy is growing faster; (b) levels of liquidity in the banking system are lower; (c) current account position deteriorates; (d) centre parties are in office; and (e) with coalitions/minority governments. Evidence of a political cycle in the duration of credit booms is also detected. Additionally, this study shows that credit booms that end up in banking crises last longer but this effect can be offset by a higher degree of Central Bank independence. Hence, a monetary authority that is not influenced by political pressures is essential to prevent the unfolding of credit booms into banking crises.

Minimising the inflationary impact of fiscal deficits in Africa: The role of monetary, financial and political institutions

AbstractThis is an examination of the relationship between fiscal deficits and inflation in Africa based on the premise that the characteristics of monetary, financial and political institutions, do impact the nature of this relationship. The study hypothesizes that, the inflationary effect of fiscal deficits is minimised when the central bank is independent (CBI) and the financial market is developed enough to contain inflationary expectations. This impact is much more effective given stronger political institutions. Using a panel data spanning 1970–2012 for 48 African countries, we use a Two Stage System Generalised Methods of Moments estimator, with Windmeijer (2005) corrected SE and collapsed instruments to address the issue of instrument proliferation. We also use various measures of central bank independence, financial development and political institutional quality. Fiscal deficits are inflationary in Africa. The positive effect of fiscal deficits on inflation is weakened when the degrees of Central Bank Independence (CBI) and financial development are higher. Financial development minimises the modulating impact of lower CBI on inflationary fiscal deficits. While stronger political institutions minimise the dampening effect of high central bank turnover on inflationary fiscal deficits, it enhances the positive impact of stronger central bank independence and financial development on minimising inflationary fiscal deficits. The results are robust to varying measures of CBI, financial development, and political institutions. Africa's financial sector should therefore be developed alongside strengthening the independence of central banks and ensuring that the quality of political institutions are enhanced in order to effectively curtail inflationary fiscal deficits.

THE “DARK SIDE” OF CREDIT DEFAULT SWAPS INITIATION: A CLOSE LOOK AT SOVEREIGN DEBT CRISES

We examine the effect of sovereign credit default swaps (CDS) trading initiation on the occurrence of sovereign debt crises (SDC). Estimations on a large sample of 141 countries for 1980–2013 reveal that, by affecting the fiscal stance, CDS initiation increases by around 1.5 percentage points on average the probability of SDC in countries with CDS compared to the other countries. This result holds for different robustness tests and is found to be stronger for developing countries, for countries with initial lower creditworthiness, and when the degrees of central bank independence and public sector transparency are low. Consequently, compared to existing work emphasizing favorable effects, CDS trading initiation is found to have adverse effects, by increasing the occurrence of SDC. These opposite effects should fuel the literature on measuring the consequences of CDS trading initiation, and its design and implementation from a policy perspective.

Inflation and fertility in a Schumpeterian growth model: Theory and evidence

This study explores a novel channel for monetary policy to impact growth and welfare—through fertility choice. In a scale-invariant Schumpeterian growth model with endogenous fertility and a cash-in-advance constraint on consumption, we find a positive effect of an increase in the nominal interest rate on fertility. The increase in fertility decreases labor supplied to production and R&D, which in turn decreases long-run growth. Calibration shows that long-run growth increases 0.12% by reducing the nominal interest rate from 9.6% to 0%, and the welfare gain is equivalent to a permanent increase in consumption of 3.14%. As an empirical test, we build panel data for 12 advanced countries during 2000–2014. We use the degree of central bank independence and money growth as the instruments for inflation. We find that the effect of inflation on population growth is positive and significant in instrumental variables estimation. Our results remain robust to using birth rate or fertility rate as the dependent variable. An increase in annual inflation of 1 percentage point would bring an increase of 0.06 percentage point in the annual growth of the total population. Our empirical findings provide support for our theory.

Beyond the Central Bank Independence Veil: New Evidence

This paper employs a new and comprehensive database of central bank institutional design to reassess the role of the independence of these public administrations in influencing the macroeconomic performance of countries, before and after the Global Financial Crisis. Using new dynamic indices, the empirical investigation takes into account the evolution of the level of independence in 65 countries over the period 1972-2014. Going beyond the standard correlation between central bank independence and inflation, we confirm the importance of the independence of these public administrations. Importantly we show that the degree of central bank independence is an endogenous variable and stress the relevance of economic and political drivers in shaping the incentives of governments to maintain or reform the governance of these public administrations.

Threefold Policies for Bank Development: Do Independence and Transparency Matter?

A well-developed banking sector is crucial to achieve a sustained economic growth. To attain this goal, both central banks and government have embraced operational and institutional arrangements. In this paper, I offer an empirical lookup on how monetary independence and transparency of macroprudential and fiscal policies are linked to bank development. Drawing upon a panel dataset for the period 1998-2014, I find that both macroprudential transparency (proxied by central bank financial stability transparency) and fiscal transparency are positively related to the share of credit granted by banks to the private sector, implying that more transparency enhances bank development. More independence from central banks seems, however, to decrease the ratio of bank credit to GDP. By considering interactions, the marginal effect of central bank financial stability transparency on bank credit/GDP, conditional on the levels of independence, is positive but decreases under a particular range of independence values. If central bank independence interacts with fiscal transparency, the marginal effect of fiscal transparency is positive and significant over a specific range of the degree of central bank independence but there is no statistical support that the marginal effect decreases within the same range unless I use the independence index of Garriga (2016).

Foreign Capital Flows, Uncertainties of Exchange Rates and Central Bank Independence: Implications for Emerging Economies

Utilizing time series data for a panel of 22 emerging countries and applying Granger causality tests, this paper extends the relationship between central bank independence (CBI) and uncertainties of inflation by including the phenomena of exchange rates and foreign capital flows. There are two specific objectives of this investigation. The first objective is to see whether uncertainty of inflation induces volatility of exchange rates, and vice versa, under differing degrees of CBI. The second objective is to explore whether the dynamics of the former relationship influence foreign capital flows in turn and, if so, whether the extent of CBI plays any role in shaping that influence. The period of study spans the years 1968 through 2013. Conditional variances for inflation and exchange rates define proxies for uncertainties of inflation and exchange rates in the empirical analysis. Additionally, annual inflows of foreign direct investment (FDI) provide measures for foreign capital flows in the analysis. Results of causality tests for high and low CBI country subgroups show interesting differences. For the high CBI countries, uncertainty of inflation and uncertainty of exchange rates do not share any causal relationship whatsoever between them. However, a weak link runs from FDI to uncertainties of inflation in the long run. This may be indicative of the disciplined monetary policy and tamed inflation in these countries. Contrastingly, for the low CBI countries, there is strong evidence of causal links running from uncertainties of inflation to uncertainties of exchange rates on the one hand and to FDI flows on the other. In addition, there is indication of a bi-directional causal link between FDI flows and exchange rates for these countries.

Independence of Central Banks in Commodity Economies

This article introduces the hypothesis that resource-rich countries display a low degree of central bank independence (CBI). This hypothesis is proven based on multivariable regression, but the influence of resource factors is not considered strong enough compared with previous inflationary experience and the characteristics of the political regime. It stresses that the impact of the commodity wealth factor on CBI choice is direct (through the share of commodity exports in total export) and indirect through the lower level of democracy in commodities countries that feature more dependent central banks. Also, this hypothesis is proven based on the grouping of countries. Such grouping shows that despite a general tendency of CBI increase in the world, a group of commodity exporting countries experiencing a substantially lower level of mean GMT-index, ECWN-index, and transparency-index resulted in lower CBI compared with groups of emerging markets and developing countries. Explaining these phenomena is rooted in features of institutional distortions in commodity economies, the specific structure of interventionist policy to overcome a "resource curse", and the specific role of the exchange rate and FX reserves in intertemporal macroeconomic policy.

Central Bankers as Supervisors: Do Crises Matter?

Following the 2007-09 Global Financial Crisis many countries have changed their financial supervisory architecture by increasing the involvement of central banks in supervision. This has led many scholars to argue that financial crises are an important driver in explaining the evolution of the role of central banks as supervisors. In this paper, we formally test whether there is any link between supervisory reforms and the occurrence of financial crises. We study the evolution of financial sector supervision by constructing a new database that captures the full set of supervisory reforms implemented during the period 1996-2013 in a large sample of countries. Our findings support the view that systemic banking crises are important drivers of reforms in supervisory structure. However, we also highlight an equally important “bandwagon” effect, namely a tendency of countries to reform their financial supervisory architecture when others do so as well. Our finding can explain how it is possible to identify a political driver in reforming the supervisory settings notwithstanding the economic theory does not indicate an optimal institutional setting. We construct several measures of spatial spillover effects and show that they can explain institutional similarities among countries and impact the probability of reforming the role of the central bank in financial sector supervision. We also stress the importance of the degree of central bank independence in the choice to concentrate financial supervision in the hands of the central bank. Our results support the view that the traditional theory of central banking has to be integrated with political economy considerations.

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. 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.

Best Article Award: Hueng

The Atlantic Economic Journal is proud to announce that the winner of the Best Article Award is C. James Hueng of Western Michigan University. His paper, entitled, “Central Bank Behavior and Statutory Independence,” appeared in the June 2012 issue of the AEJ. A distinguished committee reviewed all eligible papers published in that same year. The committee was chaired by IAES Vice President Asli Demirguc-Kunt of the World Bank. Members of the committee included the AEJ Board of Editors and IAES Endowment Fund Sponsors. The Managing Editor gratefully acknowledges the participation and diligence of all committee members who participated in the review process. The award emphasizes the intellectual and scholarly approach to economic research which has always been a focal point of the AEJ. This novel paper integrates the policy reaction function literature with the literature on central bank independence (CBI). The paper compares “what central banks actually do as opposed to what they are legislated to do.” The majority of empirical research on the time inconsistency model has been devoted to testing the relationship between economic performance and the degree of central bank independence measured by various CBI indices, such as the legal CBI. However, the distant link between institutional designs and economic performances complicates testing the relationship between the two due to endogeneity and the missing-variable issues. For this reason, the paper focuses instead on a more direct link between CBI indices and the central bank behaviors, and analyzes which aspects of the legal CBI are more consistent with central bank behaviors. Central bank behavior, which reflects the practical CBI, is described by the policy reaction function, in which the monetary policy instrument reacts to information on the state of the economy. If the legal CBI is consistent with the practical CBI, it is expected to be positively associated with the size and the speed of the central banks’ reaction to inflation shocks. The author used macro data from 18 OECD countries during the 1980s to estimate various versions of the Taylor reaction functions. Comparing the estimation results with several published CBI indices, the author found that certain aspects of legislated differences in CBI generate variations in the anti-inflation behaviors of central banks. Atl Econ J (2014) 42:1–2 DOI 10.1007/s11293-014-9412-8

The impact of central bank independence on the performance of inflation targeting regimes

This paper examines the effects of inflation targeting on inflation in both advanced and emerging economies. We do not detect significant effects in advanced economies and only find small benefits in emerging economies, in line with previous studies. However, when we differentiate the impact of inflation targeting based on the degree of central bank independence, we find large effects in emerging economies with low central bank independence. Our results therefore suggest that central bank independence is not a prerequisite for countries to experience significant declines in inflation following the adoption of inflation targeting. Furthermore, we provide evidence that one channel through which inflation targeting lowers inflation more in countries with low central bank independence is the reduction of budget deficits following the adoption of an inflation target.

Central bank independence and inflation performance: panacea or placebo?

A great deal of recent attention has been devoted towards the relationship between central bank independence and economic performance. The degree of central bank independence is said to determine cross-country inflation differences. However, several factors have been raised that cast doubts on such a relationship. First, the link between independence and inflation may not be as tight as previously declared. Also, predictive validity tests show that the link does not score favourably. Relevant variables also appear to have been omitted in using central bank independence as the determinant of cross-country inflation differences. This paper investigates the stylised facts regarding central bank independence and inflation performance. The structure of the labor market, the regulatory burden of the central bank and the exchange rate regime are found to be significant determinants as well.

The Impact of Central Bank Independence on the Performance of Inflation Targeting Regimes

This paper examines the effects of inflation targeting on inflation in both advanced and emerging economies. We do not detect significant effects in advanced economies and only find small benefits in emerging economies, in line with previous studies. However, when we differentiate the impact of inflation targeting based on the degree of central bank independence, we find large effects in emerging economies with low central bank independence. Our results therefore suggest that central bank independence is not a prerequisite for countries to experience significant declines in inflation following the adoption of inflation targeting. Furthermore, we provide evidence that one channel through which inflation targeting lowers inflation more in countries with low central bank independence is the reduction of budget deficits following the adoption of an inflation target.

The Effectiveness of Central Bank Independence vs. Policy Rules

This paper assesses the relative effectiveness of central bank independence vs. policy rules for the policy instruments in bringing about good economic performance. It examines historical changes in (1) macroeconomic performance, (2) the adherence to rules-based monetary policy, and (3) the degree of central bank independence. Macroeconomic performance is defined in terms of both price stability and output stability. Both de jure and de facto central bank independence at the Federal Reserve are considered. The main finding is that changes in macroeconomic performance during the past half century were closely associated with changes in the adherence to rules-based monetary policy and in the degree of de facto monetary independence at the Federal Reserve. But changes in economic performance were not associated with changes in de jure central bank independence. Formal central bank independence alone has not generated good monetary policy outcomes. A rules-based framework is essential.