Peaks and Troughs: Economics and Political Economy of Central Bank Independence Cycles

Abstract

This chapter investigates the endogenous evolution of central bank institutional design over the past four decades. From a theoretical perspective, it employs a stylized political economy model to highlight some key determinants of the level of central bank independence as a function of macroeconomic shocks and political economy characteristics of countries. It then employs recently developed dynamic indices of central bank design to describe the evolution of central bank independence over the period 1972–2014. In a sample of sixty-five countries, it shows that the increasing trend in central bank independence during 1972–2007 has been reversing after the 2008 financial crisis, mainly due to significant changes to the roles of central banks in banking supervision. The authors find that this evolution can be related to several macroeconomic shocks, such as inflationary, fiscal, and exchange-rate shocks.