Does central bank independence protect against fiscal dominance?

Marek A. Dąbrowski

Chapter 8 in Are Central Banks Still Conservative?, 2025, pp 185-207 from Edward Elgar Publishing

Abstract: A surge in government financing needs in the aftermath of the Covid-19 pandemic and the global financial crisis reinforced concerns about eroding monetary policy space by compelling central banks to accommodate high costs of servicing debt—that is, fiscal dominance. The chapter examines whether central bank independence (CBI) mitigates the risk of fiscal dominance attenuating the impact of public debt on interest rate policy. The sample spans from 2002 to 2022 and includes more than 50 countries, broken down into inflation targeters (ITs) and non-inflation targeters (non-ITs) using the IMF's classification. The empirical part employs a panel data technique that accounts for unobserved common factors both in covariates and error terms. The main findings are threefold. First, we detect that inflation targeting isolates against fiscal dominance. Second, we show that the framework for investigating a linkage between CBI and fiscal dominance should include accountability, which we proxy with monetary policy transparency. Third, we find that lowering exposure to fiscal dominance in ITs requires high CBI and MPT. In non-ITs, low CBI makes the interest rate response to government debt more conservative, whereas high CBI conduces to fiscal dominance, indicating that reputation enables a central bank to unload the debt burden.

Keywords: Fiscal dominance; Central bank independence; Inflation targeting; Monetary policy transparency; Government budget constraint (search for similar items in EconPapers)
Date: 2025
ISBN: 9781035337569
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