The Impact of Central Bank Independence on Political Monetary Cycles in Advanced and Developing Nations

This paper examines the extent to which monetary policy is manipulated for political purposes during elections. We do not detect political monetary cycles in advanced countries or developing nations with independent central banks. We do find evidence, however, in developing countries that lack central bank independence. Furthermore, we find some evidence that these cycles are not caused by monetization of election-related fiscal expansions. This suggests that pressure by politicians on the central bank to exploit the Phillips curve may be an important factor in generating political monetary cycles.     

Inflation targeting makes the difference: Novel evidence on inflation stabilization

Though 28 and 29 provides theoretical evidence that the introduction of inflation targeting is consistent with an inflation stabilizing monetary policy, empirical evidence that the introduction of inflation targeting actually changes central bank’s behavior is still missing. This paper aims to close this gap and estimates forward-looking monetary policy rules for 20 inflation targeting countries. To this end, we use a data set which is available to the central bank in real-time, published on a frequently basis, comparable among all countries, and which includes the periods before and after the introduction of inflation targeting. We find that the introduction of inflation targeting significantly shifts the central bank’s reaction function toward inflation stabilizing. We also provide evidence of time-varying effects and find that central banks stabilize inflation once inflation targeting is introduced. We take our results as strong evidence that the introduction of inflation targeting makes the difference for monetary policy strategies.     

Dynamic central bank independence indices and inflation rate: A new empirical exploration

It has been argued that economies with more independent central banks experience lower inflation over time. In this paper we show that this relationship is sensitive to the methodology through which central bank independence indices are constructed. We stress the importance of employing dynamic central bank independence indices in two ways. First, we perform unit root tests with structural breaks to verify if the implementation of central bank reforms represents a structural break for the inflation rate dynamics. Second, we implement a panel data analysis.We find evidence that legislative reforms that modify the degree of independence of a central bank have a strong impact on the inflation rate dynamics. Moreover, underlying the importance of employing dynamic central bank independence indices, we confirm the negative relationship between the latter and inflation for a sample of 10 OECD countries.     

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.     

Does government ideology matter in monetary policy? A panel data analysis for OECD countries

This paper examines whether government ideology has influenced monetary policy in OECD countries. We use quarterly data in the 1980.1–2005.4 period and exclude EMU countries. Our Taylor-rule specification focuses on the interactions of a new time-variant index of central bank independence with government ideology. The results show that leftist governments have somewhat lower short-term nominal interest rates than rightwing governments when central bank independence is low. In contrast, short-term nominal interest rates are higher under leftist governments when central bank independence is high. The effect is more pronounced when exchange rates are flexible. Our findings are compatible with the view that leftist governments, in an attempt to deflect blame of their traditional constituencies, have pushed market-oriented policies by delegating monetary policy to conservative central bankers.     

发达国家中央银行职能的理论与实践探讨

金融危机以来,主要发达国家的中央银行持续实施量化宽松政策,这在一定程度上模糊了货币政策与财政政策的界限,引起经济学界关于中央银行独立性问题的讨论。文章分析了中央银行独立性的概念和理论,回顾了主要发达国家量化宽松政策的实施过程,指出随着世界经济的逐步恢复与量化宽松政策的逐步退出,理顺政府与中央银行关系、强化中央银行的独立性对于保持经济长期稳定增长具有重要意义。     

Do Central Bank Forecasts Influence Private Agents? Forecasting Performance versus Signals

Focusing on a set of central banks that publish inflation forecasts in real time, this paper aims to establish whether central bank inflation forecasts influence private inflation forecasts. The response is positive in the five countries studied: Sweden, the United Kingdom, Canada, Switzerland, and Japan. Three hypotheses may explain this central bank influence: central bank forecasts are more accurate than private ones, are based on different information sets, and/or convey signals about future policy decisions and policymakers’ preferences and objectives. We provide evidence that the source of these central banks’ influence is not linked to their forecasting performance.     

Monetary conservatism and fiscal policy

Does an inflation conservative central bank à la Rogoff (1985) remain desirable in a setting with endogenous fiscal policy? To provide an answer we study monetary and fiscal policy games without commitment in a dynamic, stochastic sticky-price economy with monopolistic distortions. Monetary policy determines nominal interest rates and fiscal policy provides public goods generating private utility. We find that lack of fiscal commitment gives rise to excessive public spending. The optimal inflation rate internalizing this distortion is positive, but lack of monetary commitment generates too much inflation. A conservative monetary authority thus remains desirable. When fiscal policy is determined before monetary policy each period, the monetary authority should focus exclusively on stabilizing inflation. Monetary conservatism then eliminates the steady state biases associated with lack of monetary and fiscal commitment and leads to stabilization policy that is close to optimal.     

Monetary Policy and the Asset Risk‐Taking Channel

How important is the risk‐taking channel for monetary policy? To answer this question, we develop and estimate a quantitative monetary DSGE model where banks choose excessively risky investments, due to an agency problem that distorts banks' incentives. As the real interest rate declines, these distortions become more important and excessive risk taking increases, lowering the efficiency of investment. We show theoretically that this novel transmission channel generates a new monetary policy trade‐off between inflation and real interest rate stabilization, whereby the central bank may prefer to tolerate greater inflation volatility in order to lower excessive risk taking.     

央行资本盒与货币政策的有效性

2007年次贷危机后,各国央行都承担起“最后贷款人”的职责,救助金融机构,央行自身资产负债表的质量不断恶化,引发对中央银行资本金的关注。央行在履行维持物价稳定和一些“准财政”职能时,资本金可能遭受损失,资本金的损失会影响到央行的公信力和独立性,以及货币政策的有效性。充足的央行资本金对于货币政策的有效执行来说是一种有力的保障。     

Inflation Targeting,Fiscal Policy,and the Exchange Rate Regime

Until recently, Turkey’s economy was characterized by high inflation, undisciplined public finance management, and a fragile banking system and experienced multiple economic crises. After the economy was hit by another crisis in 2001, the central bank became independent, adopted inflation targeting as the monetary policy framework, and implemented reforms to adopt a more stringent fiscal policy. Inflation rates decreased to single-digit levels within 3 years after the independence of the central bank. This article analyzes the end of the high inflation period in the context of monetary and fiscal policy interactions within a Markov-Switching Dynamic Stochastic General Equilibrium model in which monetary and fiscal policies are allowed to switch between different regimes.     

Foreign bank penetration and the lending channel in emerging economies: Evidence from bank-level panel data

This paper examines the main implications of recently increasing foreign bank penetration on bank lending as a channel of monetary policy transmission in emerging economies. Using a dynamic panel model of loan growth, we investigate the loan granting behavior of 1273 banks in the emerging economies of Asia, Latin America, and Central and Eastern Europe during the period from 1996 to 2003. Applying the pooled OLS, system GMM, and panel VAR estimators, we find consistent evidence that foreign banks are less responsive to monetary shocks in host countries, as they adjust their outstanding loan portfolios and interest rates to a lesser extent than domestic private banks, independent of their liquidity, capitalization, size, efficiency, and credit risk, and although there exists a bank lending channel in the emerging economies, it is declining in strength due to the increased level of foreign bank penetration. We also explore possible driving factors for the different responses of foreign and domestic banks to monetary policy shocks by investigating foreign banks’ different behavior during banking crises and tranquil periods, the effects of mode of entry to host countries, the home-country effects, and the response of foreign banks from OECD countries vs. all foreign countries including non-OECD countries. We suggest the access of foreign banks to funding from parent banks through internal capital markets as the most convincing explanation.     

Firm balance sheets and monetary policy transmission

The functioning of internal capital markets in financial conglomerates facilitates a novel identification strategy of the balance sheet channel of monetary policy. We look at small subsidiary banks that are affiliated with the same holding company but operate in different geographical areas. These banks face the same marginal cost of funds due to internal capital markets, but face different borrowers as they concentrate their lending with small local businesses. Exploring cross-sectional variation in local economic conditions across these subsidiaries, we investigate whether borrower creditworthiness influences the response of bank lending to monetary policy. Our results are consistent with a demand-driven transmission mechanism that works through firm balance sheets and is independent from the bank lending channel.     

Monetary policy and financial stability in the long run: A simple game-theoretic approach

Many theoretical central bank models use short horizons and focus on a single tradeoff. However, in reality, central banks play complex, long-horizon games and face more than one tradeoff. We account for these strategic interactions in a simple infinite-horizon game with a novel tradeoff: tighter monetary policy deters financial imbalances, but looser monetary policy reduces the likelihood of insolvency. We term these factors discipline and stability effects, respectively. The central bank's welfare decreases with dependence between real and financial shocks, so it may reduce costs with correlation-indexed securities. An independent central bank cannot in general attain both low inflation and financial stability.     

The central banker as prudential supervisor: Does independence matter?

We study whether central bank independence (CBI) and monetary policy arrangements can jointly influence the likelihood of policymakers assigning banking supervision to central banks. Our empirical analysis shows that, assuming a benevolent government, a higher degree of central bank operational (economic) independence is associated with a lower probability of supervisory powers being entrusted to the monetary authority. We interpret this result as deriving from governments’ fear of the risk of excessively discretionary monetary policy. However, there is evidence that – conditional on operational independence – central banks are more involved in supervision when they pursue tighter monetary policy goals (a specific aspect of political independence). Our interpretation is that the latter may represent a commitment to mitigate central banks’ discretion in the monetization of financial distress. Our study suggests that CBI can be relevant, not only for its alleged effects on macroeconomic variables, but also in influencing policymakers’ decisions on the allocation of banking supervisory powers.     

Central bank financial strength and inflation: Is there a robust link?

Central bank financial strength has not been a fundamental issue for a substantial period of time. However, recent theoretical and empirical studies argue that central banks need to maintain a sufficient level of financial strength to perform their functions effectively and to achieve monetary policy objectives. In this study, we examine the empirical relationship between central bank financial strength and inflation using an unbalanced panel data set for a sample of selected advanced and emerging countries. We observe a statistically significant and robust negative relationship between central bank financial strength and inflation. This relationship is robust in the presence of other determinants of inflation and for alternative estimation methods. Our results have important implications for policy makers and central bankers. Particularly, our results suggest that avoiding persistent losses and maintaining the health of the central bank balance sheet remain vital pre-conditions for desirable policy outcomes of a central bank.     

Measuring the Independence of Central Banks and Its Effect on Policy Outcomes

Making the central bank an agency with the mandate and reputationfor maintaining price stability is a means by which a governmentcan choose the strength of its commitment to price stability.This article develops four measures of central bank independenceand explores their relation with inflation outcomes. An aggregatelegal index is developed for four decades in 72 countries. Threeindicators of actual independence are developed: the rate ofturnover of central bank governors, an index based on a questionnaireanswered by specialists in 23 countries, and an aggregationof the legal index and the rate of turnover. Legal independence is inversely related to inflation in industrial,but not in developing, countries. In developing countries theactual frequency of change of the chief executive officer ofthe bank is a better proxy for central bank independence. Aninflation-based index of overall central bank independence contributessignificantly to explaining cross-country variations in therate of inflation.     

Inflation Targeting as Constrained Discretion

This paper suggests a simple framework for modeling inflation targeting as constrained discretion. Although it is widely claimed that inflation targeting has been successful in maintaining low and stable inflation, an announcement of an inflation target does not by itself mean that central bankers are precommiting to how they conduct monetary policy. In comparison to the assumption of many theoretical studies, central banks conduct monetary policy in a discretionary fashion and rarely precommit to a rule in reality. Therefore, the central bank in this paper is modeled as discretionary, yet faced with a constraint, that an average of future inflation over a certain horizon should be kept on or near the preannounced target level. It is natural to add this constraint to the central banker’s optimization problem, since inflation targeting involves one way or another an evaluation of the performance over a certain horizon. So it is argued that the better outcome of inflation targeting does not come from a commitment but from “constrained discretion.” This paper also sheds some light on optimal targeting horizon.     

Monetary Policy Inclinations

We examine whether central banks should complement their inflation forecasts with interest rate projections. Introducing a central bank loss function that accounts for deviations from announcements, we incorporate the publication of policy inclinations into a dynamic monetary model. We show that in the presence of cost‐push shocks, the publication of interest rate forecasts tends to improve welfare.     

Inflation targeting,credibility, and non-linear Taylor rules

In this paper we systematically evaluate how central banks respond to deviations from the inflation target. We present a stylized New Keynesian model in which agents' inflation expectations are sensitive to deviations from the inflation target. To (re-) establish credibility, monetary policy under discretion sets higher interest rates today if average inflation exceeded the target in the past. Moreover, the central bank responds non-linearly to past inflation gaps. This is reflected in an additional term in the central bank's instrument rule, which we refer to as the ”credibility loss.” Augmenting a standard Taylor (1993) rule with the latter term, we provide empirical evidence for the interest rate response for a sample of five inflation targeting (IT) economies. We find, first, that past deviations from IT feed back into the reaction function and that this influence is economically meaningful. Deterioration in credibility (ceteris paribus) forces central bankers to undertake larger interest rate steps. Second, we detect an asymmetric reaction to positive and negative credibility losses, with the latter dominating the former.