Central Bank Independence and Inflation: the Government debt and Inflation Targeting channel
This paper examines the relationship between central bank independence, government debt levels, and inflation outcomes, with particular attention to the role of inflation targeting frameworks.
Abstract
The theoretical literature on central bank independence (CBI) predicts that more independent central banks should deliver lower and more stable inflation. While empirical support for this relationship was robust in the 1990s, subsequent research has questioned its stability across different macroeconomic environments.
We revisit this question by examining how government debt levels moderate the effectiveness of central bank independence in controlling inflation. Our hypothesis is that high levels of public debt create fiscal dominance pressures that can undermine monetary policy credibility even in formally independent central banks.
Empirical Evidence
Using a panel dataset of 35 advanced and emerging market economies over the period 1980–2015, we find evidence that the inflation-reducing effects of central bank independence are significantly attenuated when public debt exceeds approximately 80% of GDP. The inflation targeting channel appears particularly vulnerable to fiscal dominance in high-debt environments.