On Central Bank Independence and Political Cycles

Mercedes Haga

Journal of Applied Economics, 2015, vol. 18, issue 2, 267-295

Abstract: Using a large panel data set, I find that political budget cycles are significantly smaller in countries with de facto central bank independence (CBI). To explain this result and its consequences in the economy, I develop an extended New Keynesian model that incorporates a political economy model of career concerns. I find that CBI mitigates the incumbent's fiscal decisions. Intuitively, since increases in the interest rate have a negative effect on the reelection probability due to consumption postponement, this discourages expansionary fiscal policies.

Date: 2015
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DOI: 10.1016/S1514-0326(15)30012-X

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