Central bank independence and sovereign debt crisis. Any link?

: Kari Heimonen, Aleksandra Maslowska-Jokinen

Publisher: Aboa centre for Economics

: 2014

: 93

: http://ace-economics.fi/kuvat/dp93.pdf

In this paper we ask if central bank independence could lead to a

bad fiscal position of some countries. Introducing autonomous central

bank without changing other policy habits could expose the country

to greater temptation to borrow money. We think that introducing high

degree of CBI creates illusion that these countries are of similar credibil-

ity as a borrower. It opens new possibilities to borrow money and to in-

crease consumption, thus leading to greater indebtedness. We analyse

if the size of improvement in CBI was connected with country’s increase

in debt. We hypothesise that some countries could misuse the benefits

coming from CBI, would not introduce discipline in other parts of eco-

nomic policy and not only continue spending but also increase their

volumes thanks to wider options for borrowing. Panel data estimations

results using EMU-14 confirm our hypotheses. Greater increase in CBI

was related to greater increase in debt, both public and private. These

results are confirmed with alternative models and varying definitions

of central bank independence.