Central banks and civil war termination

The ability to finance conflict likely affects the odds of sustaining a war and succeeding in it. Recent literature explores rebel group funding, but far less is known about how states finance their own war efforts. This article posits that the design of central banks should affect civil war termination. In particular, it argues that central bank independence affects civil war termination through two channels. First, financial markets consider central bank independence as a good signal in terms of macroeconomic stability and debt repayment. In this way, independent central banks enhance the ability of the government to access credit to finance and end a civil war. Second, central bank independence is associated with lower inflation. Inflation control reduces one source of additional grievances that the civil war may impose on citizens. On a sample of civil wars between 1975 and 2009, central bank independence is associated with a substantial increase in the likelihood of war termination. When the form of termination is disaggregated, (higher) central bank independence is associated with a higher probability of government victory, relative to continued conflict and to other outcomes. Additional tests provide support for the argued mechanisms: during civil wars, countries with more independent central banks access international credit markets in better conditions – i.e. they pay lower interest rates, and receive longer grace and maturity periods on new debt. Furthermore, in countries experiencing civil wars, central bank independence is associated with lower inflation.

The Economic Consequences of Banking Crises: The Role of Central Banks and Optimal Independence

A large literature establishes the benefits of central bank independence, yet very few have shown directly negative economic consequences. Furthermore, while prevailing monetary theory suggests CBI should enhance management of economic distress, I argue that independent central banks exhibit tepid responsiveness to banking instability due to a myopic focus on inflation. I show that banking crises produce larger unemployment shocks and credit and stock market contractions when the level of central bank independence is high. Further, I show that these significant economic costs are mitigated when central banks do not have the inflation-centric policy mandates predominantly considered necessary. When the bank has high operational and political independence, banks’ whose policy mandate does not rigidly prioritize inflation produce significantly better outcomes during banking crises. At the same time, I show that this configuration does not produce higher inflation, suggesting it achieves a more flexible design without incurring significant costs.

Monetary Policy Trade-Offs and Monetary Policy Credibility

This chapter focuses on two key aspects of the monetary policy process: the trade-offs between the three goals that fall into the purview of central banks, price stability, output stabilization, and financial stability; and the role of central bank independence and transparency in enhancing the credibility and the efficacy of monetary policy. The chapter presents the theoretical background for each issue and discusses related empirical studies. The emphasis is on how the specific features of LFDCs impact the nature of the policy trade-offs, like informality in the labour market for the Phillips curve and the inflation–output trade-off, or the unsophisticated financial markets for financial stability concerns. In the discussion on central bank independence and transparency, the situation in LFDCs is compared with that in advanced and emerging market countries.