Central bank independence and fiscal discipline in developing countries

Abstract

This article investigates the effect of central bank independence on budget discipline in a panel of 78 developing countries from 1996 to 2020. The methodology combines the system GMM method and an estimator from the PMG (Dynamic Fixed Effects) family. The analysis uses 11 indicators of Central Bank legal independence. The results show that the degree of Central Bank independence reduces budget deficits in developing countries. However, this effect depends on the time horizon: in the short term, the Central Bank can discipline governments, but in the long term, this influence will be lost, encouraging greater fiscal laxity. This study highlights the fact that, in the long term, central bankers' independent status is inefficient for disciplining states. The main limitation of the article is that it doesn't use real indicators of Central Bank independence.

Keywords: Central bank independence; Fiscal discipline; GMM; PMG; Developing countries;

JEL classification code:  E58; E61; 055

Paper type : Empirical Research