The Credibility Premium: Central Bank Independence and Local-Currency Sovereign Yields

Adrian Alter, Julia Bersch, Albert Touna Mama and Bright Quaye

No 2026/058, IMF Working Papers from International Monetary Fund

Abstract: Central bank independence (CBI) is a key institutional feature for price stability, but its role in sovereign debt markets is less understood. This paper examines whether CBI lowers borrowing costs in local-currency sovereign debt markets in emerging and developing economies. Using data for up to 137 countries from 2000--2024, we first reaffirm that stronger CBI substantially reduces inflation and its volatility. We then show that, in normal times, a 0.1-point increase (on a 0–1 scale) in CBI is associated with lower five-year local-currency sovereign yields of 0.6–0.7 percentage points. A decomposition reveals two important mechanisms through which CBI reduces local-currency sovereign yields: lowering near-term risk compensation and compressing the term premium. In addition, we find evidence that this relationship is stronger under inflation-targeting regimes and larger in sub-Saharan Africa, but does not hold during systemic global crises. Finally, using dominance analysis, we show that domestic fundamentals explain more of the variation in yields than global factors. These findings demonstrate that debt markets directly price institutional credibility, offering clear guidance for the design of monetary frameworks.

Keywords: Sovereign yields; Local-currency bonds; Risk premium; Term premium; Inflation; Central bank independence; Cbi-inflation relationship; IMF working papers; credibility Premium Central Bank Independence; inflation volatility; IMF WP; Central bank autonomy; Currencies; Securities markets; Global; Sub-Saharan Africa; Africa (search for similar items in EconPapers)
Pages: 59
Date: 2026-03-27
New Economics Papers: this item is included in nep-cba, nep-fdg, nep-ifn and nep-mon
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