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

Published online by Cambridge University Press:  15 July 2015

Cristina Bodea  and
Masaaki Higashijima
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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
Information
British Journal of Political Science , Volume 47 , Issue 1 , January 2017 , pp. 47 - 70
Copyright
© Cambridge University Press 2015 

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Footnotes

*

Department of Political Science, Michigan State University (email [email protected]); European University Institute and Waseda University (email [email protected]). 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

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