The International Political Economy of Central Bank Independence

• In Event: Political Parties, Central Banks, and the International Economy

Abstract

Central bank independence (CBI) is understood to originate in domestic commitments to tackle inflation and government profligacy. But recent studies demonstrate a role for international financial institutions (IFIs) and capital markets in delegations to monetary authorities. Further, it is apparent that central banks have powers that extend beyond maintaining price stability. But we have yet to develop a theoretical framework that explains the origins of CBI---and reversions therefrom---that can account for these dimensions of central banking. Drawing on theories of credit cooperatives, we hypothesize that (domestic and international) creditors use CBI to resolve the informational and enforcement problems inherent to sovereign lending. Specifically, we argue that CBI is used to split sovereign agents and establish shared liabilities between governments and central banks. This separation---often buttressed by elaborate structures of surveillance and control---creates incentives for the two agents to monitor and discipline each other curtailing the moral hazard of sovereign lending. Conversely, we hypothesize that reductions in the power of lenders precipitate CBI backsliding. Using structured focused comparisons of historical cases to test our argument, we reveal dramatic variation in CBI attributable to the capacity of outside agents to `chop off the emperor's hands'.

Authors

• Andreas Kern, Georgetown University

• Jack Seddon