Skip to main content Accessibility help
×
Home
Hostname: page-component-55597f9d44-mm7gn Total loading time: 0.275 Render date: 2022-08-09T22:13:03.321Z Has data issue: true Feature Flags: { "shouldUseShareProductTool": true, "shouldUseHypothesis": true, "isUnsiloEnabled": true, "useRatesEcommerce": false, "useNewApi": true } hasContentIssue true

Central Bank Independence and Fiscal Policy: Can the Central Bank Restrain Deficit Spending?

Published online by Cambridge University Press:  15 July 2015

Abstract

Independent central banks prefer balanced budgets due to the long-run connection between deficits and inflation, and can enforce their preference through interest rate increases and denial of credit to the government. This article argues that legal central bank independence (CBI) deters fiscal deficits predominantly in countries with rule of law and impartial contract enforcement, a free press and constraints on executive power. It further suggests that CBI may not affect fiscal deficits in a counter-cyclical fashion, but instead depending on the electoral calendar and government partisanship. The article also tests the novel hypotheses using new yearly data on legal CBI for seventy-eight countries from 1970 to 2007. The results show that CBI restrains deficits only in democracies, during non-election years and under left government tenures.

Type
Articles
Copyright
© Cambridge University Press 2015 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

*

Department of Political Science, Michigan State University (email bodeaana@msu.edu); European University Institute and Waseda University (email higashij@aoni.waseda.jp). An earlier version of this article was presented at the annual meetings of the Midwest Political Science Association and the European Political Science Association 2012, as well as at the Program on International Conflict and Cooperation seminar at Texas A&M University. We thank Raymond Hicks, Andrew Kerner and Robert Franzese for comments. Three anonymous reviewers and the editor also provided excellent suggestions. An online appendix with supplementary tables and replication data are available on the journal’s website. Data replication sets and online appendices are available at http://dx.doi.org/doi:10.1017/S0007123415000058

References

Akhmedov, Akhmed, and Zhuravskaya, Ekaterina. 2004. Opportunistic Political Cycles. Quarterly Journal of Economics 119 (4):13011338.CrossRefGoogle Scholar
Alesina, Alberto, and Summers, Lawrence. 1993. Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence. Journal of Money, Credit and Banking 25 (2):151162.CrossRefGoogle Scholar
Alesina, Alberto, Hausmann, Ricardo, Hommes, Rudolf, and Stein, Ernesto. 1999. Budget Institutions and Fiscal Performance in Latin America. Journal of Development Economics 59 (2):253273.CrossRefGoogle Scholar
Allard, Julien, Catenaro, Marco, Vidal, Jean-Pierre, and Wolswijk, Guido. 2013. Central Bank Communication on Fiscal Policy. European Journal of Political Economy 30:113.CrossRefGoogle Scholar
Alt, James, and Lassen, David. 2006. Transparency, Political Polarization, and Political Budget Cycles in OECD Countries. American Journal of Political Science 50 (3):530550.CrossRefGoogle Scholar
Alt, James, and Lowry, Robert. 1994. Divided Government, Fiscal Institutions, and Budget Deficits: Evidence from the States. American Political Science Review 88 (4):811828.CrossRefGoogle Scholar
Ardagna, Silvia, Caselli, Francesco, and Lane, Timothy. 2007. Fiscal Discipline and the Cost of Public Debt Service: Some Estimates for OECD Countries. The B.E. Journal of Macroeconomics 7 (1):133.CrossRefGoogle Scholar
Arellano, Manuel, and Bover, Olympia. 1995. Another Look at the Instrumental Variables Estimation of Error Components Models. Journal of Econometrics 68 (1):2951.CrossRefGoogle Scholar
Barnhart, Scott, and Darrat, Ali. 1988. Budget Deficits, Money Growth and Causality: Further OECD Evidence. Journal of International Money and Finance 7 (2):231242.CrossRefGoogle Scholar
Bearce, David. 2008. Not Complements, But Substitutes. International Studies Quarterly 52 (4):807824.CrossRefGoogle Scholar
Beck, Nathaniel. 1984. Domestic Political Sources of American Monetary Policy: 1955-82. The Journal of Politics 46 (3):786817.CrossRefGoogle Scholar
Beck, Nathaniel, and Katz, Jonathan. 1995. What to Do (and Not to Do) with Time-Series Cross Section Data. American Political Science Review 89 (3):634647.CrossRefGoogle Scholar
Beck, Nathaniel, and Katz, Jonathan. 2004. Time-Series-Cross-Section Issues, Political Methodology working paper. Available from http://polmeth.wustl.edu/mediaDetail.php?docId=36, accessed 4 April 2012.Google Scholar
Beck, Thorsten, Clarke, George, Groff, Alberto, Keefer, Philip, and Walsh, Patrick. 2001. New Tools in Comparative Political Economy. World Bank Economic Review 15 (1):165176.CrossRefGoogle Scholar
Berger, Helge. 1997. The Bundesbank’s Path to Independence. Public Choice 93 (3):427453.CrossRefGoogle Scholar
Bernhard, William. 1998. A Political Explanation of Variation in Central Bank Independence. American Political Science Review 92 (2):311327.CrossRefGoogle Scholar
Bernhard, William, and Leblang, David. 1999. Democratic Institutions and Exchange Rate Commitments. International Organization 53 (1):7197.CrossRefGoogle Scholar
Bernhard, William, and Leblang, David. 2002. Political Parties and Monetary Commitments. International Organization 56 (4):803830.CrossRefGoogle Scholar
Blinder, Alan. 1998. Central Banking in Theory and Practice. Cambridge, MA: The MIT Press.Google Scholar
Blundell, Richard, and Bond, Steven. 1998. Initial Conditions and Moment Restrictions in Dynamic Panel Data Models. Journal of Econometrics 87 (1):115143.CrossRefGoogle Scholar
Brambor, Thomas, Clark, William, and Golder, Matt. 2006. Understanding Interaction Models: Improving Empirical Analyses. Political Analysis 14:6382.CrossRefGoogle Scholar
Brender, Adi, and Drazen, Allan. 2005. Political Budget Cycles in New Versus Established Democracies. Journal of Monetary Economics 52 (7):12711295.CrossRefGoogle Scholar
Bodea, Cristina. 2010. Exchange Rate Regimes and Independent Central Banks: A Correlated Choice of Imperfectly Credible Institution. International Organization 64 (3):411442.CrossRefGoogle Scholar
Bodea, Cristina. 2013. Independent Central Banks, Regime Type and Fiscal Performance: The Case of Post Communist Countries. Public Choice 155 (1–2):81107.CrossRefGoogle Scholar
Bodea, Cristina, and Hicks, Raymond. 2015a. Price Stability and Central Bank Independence: Discipline, Credibility and Democratic Institutions. International Organization 69 (1):127.CrossRefGoogle Scholar
Bodea, Cristina, and Hicks, Raymond. 2015b. International Finance and Central Bank Independence: Institutional Diffusion and the Flow and Cost of Capital. Journal of Politics 77 (1):268348.CrossRefGoogle Scholar
Borensztein, Eduardo, and Panizza, Ugo. 2008. The Costs of Sovereign Debt. IMF Staff Papers 56 (4):683741.CrossRefGoogle Scholar
Broz, Lawrence. 2002. Political System Transparency and Monetary Commitment Regimes. International Organization 56 (4):861877.CrossRefGoogle Scholar
Burdekin, Richard, and Laney, Leroy. 1988. Fiscal Policymaking and the Central Bank Institutional Constraint. Kyklos 41 (4):647662.CrossRefGoogle Scholar
Canzoneri, Matthew, Cumby, Robert, and Diba, Behzad. 2002. Should the European Central Bank and the Federal Reserve Be Concerned about Fiscal Policy? Rethinking Stabilization Policy Symposium, Federal Reserve Bank: Kansas City, MO.Google Scholar
Chinn, Menzie, and Ito, Hiro. 2008. A New Measure of Financial Openness. Journal of Comparative Policy Analysis 10 (3):309322.CrossRefGoogle Scholar
Clark, William, and Hallerberg, Mark. 2000. Mobile Capital, Domestic Institutions, and Electorally Induced Monetary and Fiscal Policy. American Political Science Review 94:323346.CrossRefGoogle Scholar
Clark, William, and Arel-Bundock, Vincent. 2013. Independent But Not Indifferent. Economics and Politics 25 (1):126.CrossRefGoogle Scholar
Clark, William. 2003. Capitalism, Not Globalism. Ann Arbor: University of Michigan Press.CrossRefGoogle Scholar
Crowe, Christopher. 2008. Goal Independent Central Banks. European Journal of Political Economy 24 (4):748762.CrossRefGoogle Scholar
Crowe, Christopher, and Meade, Ellen. 2008. Central Bank Independence and Transparency. European Journal of Political Economy 24 (4):763777.CrossRefGoogle Scholar
Cukierman, Alex, Miller, Geoffrey P., and Neyapti, Bilin. 2002. Central Bank Reform, Liberalization and Inflation in Transition Economies. Journal of Monetary Economics 49 (2):237264.CrossRefGoogle Scholar
Cukierman, Alex, Webb, Steven, and Neyapti, Bilin. 1992. Measuring the Independence of Central Banks and its Effect on Policy Outcomes. The World Bank Economic Review 6 (2):353398.CrossRefGoogle Scholar
Cusack, Thomas. 2001. Partisanship in the Setting and Coordination of Fiscal and Monetary Policies. European Journal of Political Research 40 (1):93115.CrossRefGoogle Scholar
Dreher, Axel, Sturm, Jan-Egbert, and de Haan, Jakob. 2008. Does High Inflation Cause Central Bankers to Lose Their Job? Evidence Based on a New Data Set. European Journal of Political Economy 24 (4):778787.CrossRefGoogle Scholar
Easterly, William, Rodriguez, Carlos Alfredo, and Schmidt-Hebbel, Klaus. 1994. Public Sector Deficits and Macroeconomic Performance. Washington, DC: The World Bank.Google Scholar
Eslava, Marcela. 2011. The Political Economy of Fiscal Deficits: A Survey. Journal of Economic Surveys 25 (4):645673.CrossRefGoogle Scholar
Fatas, Antonio, and Mihov, Ilian. 2003. The Case for Restricting Fiscal Policy Discretion. Quarterly Journal of Economics 118 (4):14191447.CrossRefGoogle Scholar
Franzese, Robert. 1999. Partially Independent Central Banks, Politically Responsive Governments, and Inflation. American Journal of Political Science 43 (3):681706.CrossRefGoogle Scholar
Franzese, Robert. 2002a. Macroeconomic Policies of Developed Democracies. New York: Cambridge University Press.CrossRefGoogle Scholar
Franzese, Robert. 2002b. Electoral and Partisan Cycles in Economic Policies and Outcomes. Annual Review of Political Science 5:369421.CrossRefGoogle Scholar
Furceri, Davide, and Zdzienicka, Aleksandra. 2012. How Costly are Debt Crises? Journal of International Money and Finance 31 (4):726742.CrossRefGoogle Scholar
Gasiorowski, Mark. 2000. Democracy and Macroeconomic Performance in Underdeveloped Countries: An Empirical Analysis. Comparative Political Studies 33 (3):319349.CrossRefGoogle Scholar
Greenspan, Alan. 2008. The Age of Turbulence: Adventures in a New World. London: Penguin Press.Google Scholar
Grilli, Vittorio, Masciandaro, Donato, and Tabellini, Guido. 1991. Political and Monetary Institutions and Public Financial Policies in the Industrial Countries. Economic Policy 6 (13):341392.CrossRefGoogle Scholar
Hallerberg, Mark. 2002. Veto Players and Monetary Commitment Technologies. International Organization 56 (4):775802.CrossRefGoogle Scholar
Hallerberg, Mark, Vinhas de Souza, Lucio, and Clark, William. 2002. Political Business Cycles in EU Accession Countries. European Union Politics 3 (2):231250.CrossRefGoogle Scholar
Hallerberg, Mark, and Marier, Patrick. 2004. Executive Authority, the Personal Vote, and Budget Discipline in Latin American and Caribbean Countries. American Journal of Political Science 48 (3):571587.CrossRefGoogle Scholar
Henisz, Witold. 2002. The Institutional Environment for Infrastructure Investment. Industrial and Corporate Change 11 (2):355389.CrossRefGoogle Scholar
Hibbs, Douglas. 1987. The American Political Economy: Macroeconomics and Electoral Politics in the United States. Cambridge, MA: Harvard University Press.Google Scholar
Hicks, Raymond. 2004. The Politics of Central Bank Reform: The Role of Institutions, Partisanship, and International Economics. PhD dissertation, Department of Political Science, Emory University, Atlanta, GA.Google Scholar
Ilzetzki, Ethan, Reinhart, Carmen, and Rogoff, Kenneth. 2008. Exchange Rates Agreements Entering the 21st Century, Unpublished manuscript and data.Google Scholar
Jacome, Luis, and Vazquez, Francisco. 2008. Any Link Between Legal Central Bank Independence and Inflation? European Journal of Political Economy 24 (4):788801.CrossRefGoogle Scholar
Keefer, Philip, and Stasavage, David. 2003. The Limits of Delegation: Veto Players, Central Bank Independence, and the Credibility of Monetary Policy. American Political Science Review 97 (3):407423.CrossRefGoogle Scholar
Laubach, Thomas. 2009. New Evidence on the Interest Rate Effects of Budget Deficits and Debt. Journal of European Economic Association 7 (4):858885.CrossRefGoogle Scholar
Leone, Alfredo. 1991. Effectiveness and Implications of Limits on Central Bank Credit to the Government. In The Evolving Role of Central Banks, edited by Patrick Downes and Reza Vaez-Zadeh, 363413. Washington, DC: IMF.Google Scholar
Linzer, Drew, and Staton, Jeffrey. 2012. A Measurement Model for Synthetizing Multiple Comparative Indicators. Working paper. Atlanta, GA: Emory University.Google Scholar
Lohmann, Susanne. 1992. Optimal Commitment in Monetary Policy: Credibility Versus Flexibility. American Economic Review 82:273286.Google Scholar
Lohmann, Susanne. 1998. Federalism and Central Bank Independence, 1957–92. World Politics 50 (3):401446.CrossRefGoogle Scholar
Maxfield, Sylvia. 1997. Gatekeepers of Growth. Princeton, NJ: Princeton University Press.Google Scholar
Melitz, Jacques. 2002. Debt, Deficits and the Behavior of Monetary and Fiscal Authorities. In The Behavior of Fiscal Authorities – Stabilization, Growth and Institutions, edited by Marco Buti, Jürgen von Hagen and Carlos Martinez-Mongay. London: Palgrave Macmillan, 215240.Google Scholar
Milesi-Ferretti, Gian Maria, Perotti, Roberto, and Rostagno, Massimo. 2002. Electoral Systems and Public Spending. Quarterly Journal of Economics 117 (2):609657.CrossRefGoogle Scholar
Moser, Peter. 1999. Checks and Balances, and the Supply of Central Bank Independence. European Economic Review 43 (8):15691593.CrossRefGoogle Scholar
Moser-Boehm, Paul. 2006. The Relationship Between the Central Bank and the Government. Paper Presented at the Special Meeting of Governors Central Banks and the Challenge of Development. Bank for International Settlements, May, Basel.Google Scholar
Neyapti, Bilin. 2003. Budget Deficits and Inflation. Contemporary Economic Policy 21 (4):458475.CrossRefGoogle Scholar
Nordhaus, William. 1975. The Political Business Cycle. Review of Economic Studies 42 (2):169190.CrossRefGoogle Scholar
Oatley, Thomas. 1999. How Constraining is Capital Mobility? American Journal of Political Science 43 (4):10031027.CrossRefGoogle Scholar
Olson, Mancur. 1993. Dictatorship, Democracy, and Development. American Political Science Review 87 (3):567576.CrossRefGoogle Scholar
O’Mahony, Angela. 2011. Engineering Good Times. British Journal of Political Science 41 (2):315340.CrossRefGoogle Scholar
Persson, Torsten, and Svensson, Lars E.O.. 1989. Why a Stubborn Conservative Would Run a Deficit. Quarterly Journal of Economic 104 (2):325345.CrossRefGoogle Scholar
Plümper, Thomas, and Troeger, Vera. 2007. Efficient Estimation of Time-Invariant and Rarely Changing Variables in Finite Sample Panel Analysis with Unit Fixed Effects. Political Analysis 15 (2):124139.CrossRefGoogle Scholar
Polillo, Simone, and Guillén, Mauro F.. 2005. Globalization Pressures and the State. American Journal of Sociology 110 (6):17641802.CrossRefGoogle Scholar
Reinhart, Carmen, and Rogoff, Kenneth. 2004. The Modern History of Exchange Rate Arrangements. Quarterly Journal of Economics 119 (1):148.CrossRefGoogle Scholar
Rogoff, Kenneth. 1985. The Optimal Degree of Commitment to an Intermediate Monetary Target. The Quarterly Journal of Economics 100:11691189.CrossRefGoogle Scholar
Roodman, David. 2009. How to Do xtabond2: An Introduction to ‘Difference’ and ‘System’ GMM in Stata. Stata Journal 9 (1):86131.Google Scholar
Schuknecht, Ludger. 1996. Political Business Cycles in Developing Countries. Kyklos 49 (2):155170.CrossRefGoogle Scholar
Shi, Min, and Svensson, Jakob. 2006. Political Budget Cycles in Developed and Developing Countries. Journal of Public Economics 90 (8–9):13671389.CrossRefGoogle Scholar
Sikken, Bernd Jan, and de Haan, Jakob. 1998. Budget Deficits, Monetization, and Central Bank Independence in Developing Countries. Oxford Economic Papers 50 (3):493511.CrossRefGoogle Scholar
Simmons, Beth. 1996. Rulers of the Game. International Organization 50 (3):407443.CrossRefGoogle Scholar
Stasavage, David. 2003. Transparency, Democratic Accountability, and the Economic Consequences of Monetary Institutions. American Journal of Political Science 47 (3):389402.CrossRefGoogle Scholar
Tabellini, Guido. 1987. Central Bank Reputation and the Monetization of Deficits. Economic Inquiry 25 (2):185200.CrossRefGoogle Scholar
Treisman, Daniel. 2000. Decentralization and Inflation. American Political Science Review 94 (4):837855.CrossRefGoogle Scholar
Vlaicu, Razvan, Verhoeven, Marijn, Grigoli, Francesco, and Mills, Zachary. 2014. Multiyear Budgets and Fiscal Performance: Panel Data Evidence. Journal of Public Economics 111:7995.CrossRefGoogle Scholar
Von Hagen, Jurgen. 2002. Budgetary Institutions for Sustainable Public Finances. In The Behavior of Fiscal Authorities, edited by Marco Butti, Jurgen Von Hagen and Carlos Ballabriga. New York: Palgrave Macmillan, 94112.Google Scholar
Wooldridge, Jeffrey. 2002. Econometric Analysis of Cross Section and Panel Data. Cambridge, MA: MIT Press.Google Scholar
Supplementary material: PDF

Bodea and Higashijima supplementary material

Appendices

Download Bodea and Higashijima supplementary material(PDF)
PDF 157 KB
Supplementary material: File

Bodea and Higashijima supplementary material

Bodea and Higashijima supplementary material 1

Download Bodea and Higashijima supplementary material(File)
File 1 MB
42
Cited by

Save article to Kindle

To save this article to your Kindle, first ensure coreplatform@cambridge.org is added to your Approved Personal Document E-mail List under your Personal Document Settings on the Manage Your Content and Devices page of your Amazon account. Then enter the ‘name’ part of your Kindle email address below. Find out more about saving to your Kindle.

Note you can select to save to either the @free.kindle.com or @kindle.com variations. ‘@free.kindle.com’ emails are free but can only be saved to your device when it is connected to wi-fi. ‘@kindle.com’ emails can be delivered even when you are not connected to wi-fi, but note that service fees apply.

Find out more about the Kindle Personal Document Service.

Central Bank Independence and Fiscal Policy: Can the Central Bank Restrain Deficit Spending?
Available formats
×

Save article to Dropbox

To save this article to your Dropbox account, please select one or more formats and confirm that you agree to abide by our usage policies. If this is the first time you used this feature, you will be asked to authorise Cambridge Core to connect with your Dropbox account. Find out more about saving content to Dropbox.

Central Bank Independence and Fiscal Policy: Can the Central Bank Restrain Deficit Spending?
Available formats
×

Save article to Google Drive

To save this article to your Google Drive account, please select one or more formats and confirm that you agree to abide by our usage policies. If this is the first time you used this feature, you will be asked to authorise Cambridge Core to connect with your Google Drive account. Find out more about saving content to Google Drive.

Central Bank Independence and Fiscal Policy: Can the Central Bank Restrain Deficit Spending?
Available formats
×
×

Reply to: Submit a response

Please enter your response.

Your details

Please enter a valid email address.

Conflicting interests

Do you have any conflicting interests? *