When Doves Act Like Hawks: Central Bank Independence and Monetary Preferences

• In Event: New Perspectives on Central Banking

Abstract

A large literature has examined the role of central bank independence (CBI) on macroeconomic outcomes, with many emphasizing the importance of conservative (hawkish) central bankers in achieving lower inflation. However, few have explicitly examined how independence shapes the preferences of central bankers on monetary policymaking committees. The extant literature which does explore this issue suggests that CBI, rather than mitigating inflation, magnifies the distinctions over monetary preferences and can lead to harmful inflationary outcomes when liberal (dovish) central bankers dominate the committee. Contrary to this expectation, we argue that CBI anchors differences over monetary preferences and suppresses the inflationary bias of dovish central bankers. Using a new 114 country panel dataset on the appointment of central bank governors, we use economic conditions – times of economic distress – in the year of governor appointments as a proxy for governor dovishness, and generate an economic distress index which describes the overall dovishness of the policymaking committee. In line with our anchoring theory, we find that a higher proportion of governors appointed during times of distress does predict higher inflation but that this effect predominates only at lower levels of CBI. Dovish central bankers do not significantly predict higher inflation when the level of CBI is sufficiently high. We further find that CBI can lead to higher inflation with dovish central bankers, but only when institutions are fairly weak.

Authors

• Daniel Hansen, Carnegie Mellon University

• Cristina Bodea, Michigan State University