Central bank autonomy, legal institutions and banking crisis incidence

Abstract

We examine whether the autonomy of a country's central bank (CB) reduces the probability of a banking crisis. We take a fine-grained approach to CB autonomy by disentangling its various components as well. In addition, we look at the joint effects of CB autonomy and the legal tradition on the probability of a banking crisis in a country. Using the cross-country data for CB independence for the period of 1980-1989, and both binary and ordered logit estimation models, this study finds that a country's CB with more autonomy in aggregate can lessen the probability of a banking crisis. When the CB's autonomy is disentangled with respect to its responsibilities, this study finds that the longer the tenure of the CB's chief executive officer, the lower the probability of a banking crisis. We also find that the probability of a banking crisis in the country is reduced even more if the relatively more autonomous CB can perform its duties in line with the country's stronger law-and-order tradition. We also carry out some counterfactual thought experiments along these lines. © 2011 John Wiley & Sons, Ltd.