How the Independence of Central Bank Is Effective on the Financial Stability in Emerging Markets Countries?

Document Type : پژوهشی

Authors

• Mehdi Yazdani ¹
• Seyed Komail Tayebi ²
• Nafiseh Yazdani ²

¹ Shahid Beheshti University

² University of Isfahan

https://doi.org/10.22067/pm.v22i9.34979

Abstract

Economists believe that except the commitment of central bank about price stability, this institution should consider some arrangements for financial stability in macro level of economic. However, financial stability leads to smoothly and uniformly performance in different parts of financial system such as financial institutions, markets and system of financial pay off (Cihak, 2007; Oosterloo and De Haan, 2004).
Moreover, the major parts of economic literatute have emphasized on central bank independence rather than price stability. Available studies discus that in addition to the price stability, the dependence of central bank leads to financial stability, so that regulatory and supervisory independence are necessary to achieve and maintain stability in financial sector of economic (Klomp and De Haan, 2009; Meade and Crowe, 2007; Cukierman, 2008).
This study tries to evaluate the relation between the dependence of central bank and some indices of financial stability using a dynamic panel data model during 1980-2012 in selected emerging market countries (namely are Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, South Korea, Malaysia, Mexico, Morocco, Peru, Philippine, Russia, South Africa, Thailand, Turkey and Iran). In the paper, different types of financial instability indices have been used which have been divided in three categories. The first category is as banking system indices (including change in ratio of bank liabilities to GDP, change in ratio of bank liquid reserves to bank assets, change in ratio of bank capital to assets, change in domestic credit provided by banking sector (% of GDP) and change in domestic credit to private sector (% of GDP)), the second is as risk and return indices (including change in real interest rate, change in interest rate spread and change in risk premium on lending) and the third is monetary authorities indices (including change of money and quasi money (M2) to GDP and change in net foreign assets to GDP).
The macroeconiomic control variables are the inflation rate, the economic growth rate, the change in exchange rate and the shocks of term on trade. Moreover gross domestic product per capita to mesure the differences in development level of countries, the budget deficit as an influent variable on central bank independence, the financial liberalization since of its role on risk of financial instutions and the insurance of deposits have been includeed to model. Also to consider the effect of globalization on financial instability, this variable has been added to model which may have positive or negative sign dependent on quality of golobalization phenomenon. Finally the net financial flows as a represenetive variable for international capital flows phenomena (including bonanza, sudden stop and capital flight) has been added to model which can consider the vulnerability of financial sytem to this outcomes.
The estimated results show that the dependence variable of central bank including political, economic and overall dependence variables, lead to decrease the financial instability in selected emerging market countries. Moreover, for other control variables, the theoretical expectations have been confirmed where the relationship between economic growth and financial instability is negative and the movements in term of trade, exchang rate and inflation lead to financial instability. Also the coefficient of budeget deficit shows that there is a direct link between rasie in budget deficit and financial instability via its effects on regularity of central bank. According to results, the insurance of deposit is a way which policy makers can control financial istability. Finally the effects of globalization on financial istability is positive which the phenomenon can arise some difficulties for emertging market economies.
As a policy implication for Iranian economy based on estimated results of model: i) the independence of central bank is critical for Iranian economy to stabilize the dynamic financial system, ii) the regular and sytematinc fiscal policies are necessitate for financial stability in Iranian econmy, iii) introducing new financial instruments and derivates such as deposit insurance are vital for financial stability in Islamic Banking and finally, iiii) as a buffering element for unfavorable effects of globalization on financial instability, the independence of central bank is determinant too.

Keywords

• Independence of Central Bank
• Financial Stability
• Regulatory and Supervisory Independence
• Dynamic Panel Data Model

References

[1] Acemoglu, D, S. Johnson, P. Querubin and J. Robinson. (2008). When Does Policy Reform Work? The Case of Central Bank Independence. NBER Working, Paper: 14033.

[2] Alesina, A. and A. Drazen. (1991). Why Are Stabilizations Delayed. American Economic Review, 81(5), 1170–1188.

[3] Arellano, M. and O. Bover. (1995). Another Look at the Instrumental Variable Estimation of Error-components Models. Journal of Econometrics, 68(1), 29–51.

[4] Arellano, M. and S. Bond. (1991). Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations. Review of Economic Studies, 58(2), 277–297.

[5] Arnone, M., B. Laurens, J. Segalotto and M. Sommer. (2007). Central Bank Autonomy: Lessons from Global Trends. IMF Working 07/88.

[6] Beck, T., A. Demirguc-Kunt and R. Levine. (2006). Bank Concentration, Competition, and Crises: first Results. Journal of Banking and Finance, 30(5), 1581–1603.

[7] Blundell, R. and S. Bond. (1998). Initial Conditions and Moment Restrictions in Dynamic Panel Models. Journal of Econometrics, 87(1), 115–143.

[8] Caprio, G. and D. Klingebiel. (1996). Bank Insolvencies: Cross Country Experience. World Bank Policy Research Working Paper: 1620.

[9] Cihak, M. (2007). Central Bank Independence and Financial Stability. IMF, Mimeo.

[10] Cihak, M. (2010). Price Stability, Financial Stability, and Central Bank Independence. 38th Economics Conference at the Oesterreichische Nationalbank, Vienna.

[11] Cukierman, A. (2008). Central Bank Independence and Monetary Policy-making Institutions: Past, Present and Future. European Journal of Political Economy, 24(4), 722–736.

[12] De Gregorio, J. (2011). Price and Financial Stability in Modern Central Banking. Keynote Speech, Governor of the Central Bank of Chile, at the joint Latin American and Caribbean Economic Association (LACEA)-Latin American Chapter of the Econometric Society (LAMES) Conference 2011, University Adolfo Ibañez, Santiago, November 11.

[13] Frankel, J. (1999). Preventing Banking Crises. In: Caprio, G., Hunter, C., Kaufman, G., Leipsiger, D. (Eds.). Preventing Bank Crises: Lessons from Recent Global Bank Failures, World Bank Publications.

[14] Garcia Herrero, A. and P. Del Rio. (2003). Financial Stability and the Design of Monetary Policy. Banco de Espa˜na Working, Paper: 0315.

[15] Grilli, V., D. Masciandaro and G. Tabellini. (1991). Political and Monetary Institutions and Public Financial Policies in the Industrial Countries. Economic Policy, 13, 341–392.

[16] Hutchison, M. and K. McDill. (1999). Are all Banking Crises alike?. Journal of the Japanese and International Economies, 12(3), 155–180.

[17] Kaminsky, G. and C. Reinhart. (1999). The Twin Crises: the Causes of Banking and Balance-of-payment Problems. American Economic Review, 89(3), 473–500.

[18] Keefer, P. (1999). When do Special Interests Run Rampant? Disentangling the role of Elections, Incomplete Information and Checks and Balances in Banking Crises. World Bank Policy Research Working Paper 2543.

[19] Klomp, J. and J. De Haan. (2009). Central Bank Independence and Financial Instability. Journal of Financial Stability, 5, 2008-03.

[20] Meade, E. and C. Crowe. (2007). The Evolution of Central Bank Governance around the World. Journal of Economic Perspectives, 21(4), 69–90.

[21] Oosterloo, S. and J. De Haan. (2004). Central Banks and Financial Stability: a Survey. Journal of Financial Stability, 1(2), 257–273.

[22] Quintyn, M. and M. Taylor. (2003). Regulatory and Supervisory Independence and Financial Stability. CESifo Economic Studies, 49, 259–294.