Central Bank’s Independence and Stock Prices

doi:10.4236/me.2012.36101

Paper Menu >>

Journal Menu >>

Modern Economy, 2012, 3, 793-797

http://dx.doi.org/10.4236/me.2012.36101 Published Online October 2012 (http://www.SciRP.org/journal/me)

Central Bank’s Independence and Stock Prices

Yutaka Kurihara1, Koichiro Morikawa2, Sadayoshi Takaya3

1Faculty of Economics, Aichi University, Nagoya, Japan

2Faculty of Economics, Kinki University, Higashiosaka , Japan

3Faculty of Commerce, Kansai University, Suita, Japan

Email: [email protected]

Received September 13, 2012; revised October 13, 2012; accepted October 20, 2012

ABSTRACT

Since the end of 1990s, the independence of central bank independence has been discussed. In the past, central banks

tried to improve their independence to combat inflation. This independence has been evaluated relative to adequate

economic policy and stable economic growth. This article examines the effect of central bank independence on stock

market prices and finds evidence for a positive return in developed coun tries; moreover, for stock prices, economic in-

dependence of the central bank seems to be more important than political independence.

Keywords: Central Bank Independence; Mone tary Policy; Stock Price

1. Introduction

An independent central bank is considered necessary for

the conduct of credible monetary policy that is com-

mitted to maintain stab le inflation [1]. On the o ther hand,

central banks are responsible for the conduct of monetary

policy and output [2]. Many studies have noted that

higher degrees of central bank independence can keep

inflation stable [3,4]. On the other hand, [5] showed that

the negative relationship between central bank inde-

pendence and inflation could not be found by examining

the effects on some macroeconomic and institutional

variables. As noted in these studies, there is much room

for the role of central bank independence to influence for

market performance. This article provides evidence that

focuses on the question of whether a greater degree of

central bank independence results in greater stock re-

turns.

One serious problem exists in this area: very limited

data are available regarding reliable central bank inde-

pendence. Only a few studies have provided this type of

data. [4] compared Alestina and Summers’s data with

those of [6] and found a large increase in central bank

independence. To collect the same data and link different

time data in one series is difficult. To make a central

bank index based on these analyses is still more difficult

because the data are sometimes limited. Also, reliable

data based full on the past is almost impossible. Some

possibility exists that different situations may have im-

pacted the determination of central bank independence.

On the other hand, a few studies have been evaluated

highly and cited often. Moreover, the use of data for em-

pirical analysis sometimes causes problems as these es-

tablished papers provide fixed data for some sample

period.

This article contributes to the limited literature that

goes beyond the effects of central bank independence on

inflation ([7-9]). [10] focused on the effects of central

bank independence on exchange rates. [11] found that

central bank independence favorably affected employ-

ment rates. However, as there has been little reliable and

broadly accepted data for central bank independence,

especially for the recent period, the need to analyze the

relationship between central bank independence and eco-

nomic variables has increased. This article responds to

this need.

[11] stated that an independent central bank fosters

stock market returns by constraining inflation. [12,13]

investigated the effect of central bank independence on

stock market in emerging economies. The former found

that high government turnover has a negative effect on

stock market returns. The latter indexed central bank

independence index into two categories (i.e., economic

and political) and found evidence for a positive return;

however, the economic independence of the central bank

seems to be more important than political independence

in developing and emerging countries.

However, few studies have considered central bank

independence relative to many countries, the recent pe-

riod, and the effects of central bank independence on

macroeconomic variables. Few studies have assessed the

relationship between stock prices and macroeconomic

variables.

This article examines empirically the effects of central

Y. KURIHARA ET AL.

794

bank independence on stock prices as well as the effects

of some macroeconomic variables on stock prices. The

central bank independence index is drawn from two fa-

mous ones [1,13], which have been cited frequently. Two

groups of countries area used for this analysis: dev eloped

economies and developing/emerging economies. A com-

parison of these categories seems very important for the

conduct of monetary policy and for stable growth. Al-

though the ideal would be to use a reliable central bank

index, it is difficult to collect this type of data. Two reli-

able data [9,13] are employed in this article. However,

political and economic elements of the two indices are

distinguished to analyze the effects of the central bank

independence and some economic variables on stock

prices.

2. Theoretical Analysis

This article empirically examines the effect of central

bank independence and economic variables on stock

market prices. The equation for the empirical analysis is

as follows:

STOCKit = Const + αCBIit + βXit + εit (1)

STOCK means year-to-year p ercentage change of stock

prices. CBI denotes central bank independence index. X

means four macroeconomic variables related to stock

prices (explained in 3-1 in detail). i denotes country and t

means time. This equation is orthodox and not new as

based on [1]. Both the effect of CBI effect on stock

prices and some related macroeconomic variables with

stock prices and goals of central banks are added as ex-

planation variables for empirical estimation. This equa-

tion is orthodox and not new as based on [1].

The effect of CBI on stock prices is the main focus of

this article; it cannot be omitted. Second, almost all of

the central banks conduct their policies to attain stable

inflation rates. Inflation rate should be examined. Third,

interest rate is the most important factor for determina-

tion of stock prices. It is added as an explanation variable.

Fourth, as most central banks are interested in economic

growth, GDP growth is used as an explanation variable.

Finally, export growth is added as an explanation vari-

able as per [1], because not only the cases of developed

but also those of emerging and developed countries are

employed for estimation. Some developing and emerging

economics depend on exports for economic growth, na-

mely, in stock prices.

The main interest is in the effects of CBI on stock

prices. The CBI indices used here are the Cukierman and

Arnone index of the subindices for political independ-

ence and economic independence, together and in total.

All measures of CBI are measured for the period for

which the returns are calculated. Changes do not always

represent permanent shifts in the level of the CBI proxy.

3. Empirical Method and Results

3.1. Empirical Method

The data are yearly. For central bank independence, the

data derived from [9,13] are both used. The two papers

provided data regarding central bank independence; all

data are fixed. The sample periods are from 1989 to 1992

for the index of [13] and from 2005 to 2007 for the index

of [9]. These indices are based on information about cen-

tral bank independence across 10 dimensions. [9,13] are

combined with different weights in an economic and

political independence index. Both economic and politi-

cal factors are taken into account.

[14] found that the differences in behaviors among

central banks are consistent with the economic measure

of independence, which measures how easy it is for the

government to finance its deficits by direct access to

credit from the central bank. For example, one of the

economic differences is whether or not the central bank

is obliged to finance government debt, and one of the

political differences is the relationship between the cen-

tral bank and the government in determining monetary

policy. Both economic and political elements should be

considered in determining the central bank index.

This article divides the countries into two groups: 1)

developed countries and 2) developing or emerging

countries. For developed countries, the countries esti-

mated are Australia, Austria, Belgium, Korea, Nether-

lands, New Zealand, Norway, Portugal, Singapore, Spain,

Sweden, Switzerland, the United Kingdom, and the Uni-

ted States. Developing and emerging economies include

Barbados, Columbia, Israel, Malta, Peru, Philippines,

South Africa, Turkey, and Venezuela. Only the countries

selected were examined in this analysis due to the data

available.

The stock market prices are percentage year-to-year

change and are used for dependent variables. Explana-

tory variables include the index of central bank inde-

pendence, inflation, GDP growth, export growth, and in-

terest rate. All of the data except the index of central

bank independence are percentage year-to-year change

and are from International Financial Statistics (Interna-

tional Monetary Fund). Three indices are used for central

bank independence: total, economic, and political.

It is necessary to check unit root tests for estimation.

This paper uses two typical methods: augmented Dickey-

Fuller (ADF) and Phillips-Perron (PP). ADF is most used

for empirical estimation; however, if the series is corre-

lated at higher order lags, the assumption of white noise

disturbances is violated. The PP test proposes a method

by which to control for higher order serial correlation in

a series than is accepted in the equation. The test makes a

Y. KURIHARA ET AL. 795

nonparametric correction to the t-test statistic. This is

robust with respect to unspecified autocorrelation and

heteroscedasticity in the disturbance process of the test

equation.

The results of two methods explained are in Tables

1(a)-(c). In a few cases, the results are mixed and are not

perfectly conclusive. However, almost all of the results

are not problematic for empirical estimations.

3.2. Empirical Results

The results of the equation (1) are shown in Tables 2(a)-

(c). The regression method is OLS (ordinary least squa-

red).

The results are clear. Central bank independence has

positive impact on stock prices in general. However, the

results show that it is necessary to distinguish developed

countries from other countrie s. The results show positive

evidence that central bank independence increases stock

Table 1. (a) Unit root test: Total countries; (b) Unit root test:

Developed countries; (c) Unit root test: De ve loping and emer-

ging countries.

(a)

ADF PP

Stock return –3.20*** –52.80***

Inflation 0.23 –62.89***

GDP growth –3.36*** –20.89***

Export growth –3.03** –48.12***

Interest rate –0.37 –63.14***

(b)

ADF PP

Stock return –3.24*** –47.02***

Inflation –2.43** –32.61***

GDP growth –3.93*** –40.28***

Export growth –1.63* –59.36***

Interest rate –2.60** –32.47***

(c)

ADF PP

Stock return –2.46** –17.88***

Inflation –2.37** –16.16***

GDP growth –2.04** –18.22***

Export growth –3.88*** –9.69***

Interest rate –2.44** –10.37***

Note. ***means significant at 1%, **means at 5%, a nd *means at 10% level.

Table 2. (a) Effects of central bank independence on stock

returns: Total countries; (b) Effects of central bank inde-

pendence on stock re turns: Developed countries; (c) Effects

of central bank independence on stock returns: Developing

and emerging countries.

(a) Central bank independence

Variable Political Economic Total

C –20.75

(–1.61) –41.89**

(–2.71) –44.48**

(–3.00)

Stock return (–1) 0.47

(2.79) 0.41**

(2.53) 0.47**

(2.95)

Central bank independence42.06**

(2.75) 54.72***

(3.58) 70.91***

(3.99)

Inflation rate 2.73***

(19.36) 0.14***

(19.87) 2.67***

(19.70)

GDP growth –0.78

(–0.51) –0.55

(–0.37) –0.07

(–0.05)

Export growth 0.15

(0.28) 0.50

(1.00) 0.18

(0.38)

Interest rate –0.14

(–0.26) 0.06

(0.16) 0.15

(0.29)

Adj.R2 0.99 0.99 0.99

F-statistic 15170.83 16409.09 17142.20

Durbin Watson 2.40 2.32 2. 2 8

(b) Central bank independence

Variable Political EconomicTotal

C 9.61

(1.19) –9.18

(–0.79) –1.79

(–0.15)

Stock return (–1) 0.32**

(2.88) 0.37***

(3.47) 0.36**

(3.21)

Central bank independence 0.62

(0.08) 18.22**

(1.96) 14.47

(1.20)

Inflation rate –1.85

(–1.34) –1.23

(–0.93) –1.30

(–0.93)

GDP growth –2.34**

(–2.21) –1.70*

(–1.60) –1.84*

(–1.70)

Export growth 1.42***

(4.10) 1.53***

(4.84) 1.37***

(4.21)

Interest rate –0.88

(–1.19) –0.70

(–0.99) –0.87

(–1.20)

Adj.R2 0.93 0.98 0.95

F-statistic 9.20 10.79 9.79

Durbin Watson 1.62 1.64 1.64

Variable Political EconomicTotal

C –24.53

(–0.81) –31.51

(–0.89) –36.48

(–1.08)

Stock return (–1) 0.53

(1.47) 0.44

(1.33) 0.43

(1.16)

Central bank independence 74.50

(1.15) 48.03

(1.00) 80.86

(1.31)

Inflation rate 2.58***

(8.58) 2.55***

(8.51) 2.59***

(8.75)

GDP growth 2.13

(0.75) 2.04

(0.66) 2.12

(0.70)

Export growth –1.13

(–1.02) –0.93

(–0.84) –1.05

(–0.96)

Interest rate 0.49

(0.43) 0.71

(0.64) 0.57

(0.53)

Adj.R2 0.99 0.99 0.99

F-statistic* total 5970.871 5846.20 6011.03

Durbin Watson* total 2.34 2.34 2.38

Note. *** means significant at 1%, ** means at 5%, and * means at 10% level.

Y. KURIHARA ET AL.

796

prices for developed economies, however, the relation-

ship cannot be found for developing and emerging eco-

nomies. Also, there is large difference between the usage

of the political element and the econ omic element.

All of the coefficients of central bank independence on

stock prices are positive and significant for developed

economies. However, only the economic indices are sig-

nificant. The effects of inflation on stock prices reflect

the results that adj. R2s are small in Table 2(b). For the

case of developing and emerging economies, the coeffi-

cients are positive as expected; however, not all of them

are significant.

The results show strongly that it would be dangerous

to state that improvements in central bank independence

cause stock prices to rise. Considering economic condi-

tions/stages and elements of central bank independence

would be necessary for policymakers to attain economic

development. Also, economic elements of central bank

independence should be carefully examined. Systematic

and reasonable policy for economic development to fit

each economy would be necessary and important.

It is interesting to note th at exporting growth promotes

stock price rising in developed countries (but not in de-

veloping and emerging economies). GDP growth is not

necessarily linked to increases in stock prices. In devel-

oping and emerging economies, inflation promotes in-

creased stock prices. Deflation and domestic demand

have been serious in developed economies, which may

have some effect on these results.

Also, it is interesting to note that central bank inde-

pendence increases inflation for developing and emerg-

ing economies. The reason is difficult to understand.

There is some possibility that central banks which have

high independence do not strong emphasis on inflation.

Also, inflation may be caused by other factors such as

asset prices.

The Granger causality test was performed to check the

hypothesis (see Tables 3(a)-(c)). The Granger causality

test is a statistical hypothesis test that de termines wh eth er

a time series is useful for forecasting. A time series X is

said to Granger cause Y if it can be shown in a serious of

F tests on lagged values of X and that those X values

provide significant data about future values of Y.

The results show positive evidence that central bank

independence increases stock prices.

4. Conclusions

This article examined the effects of central bank inde-

pendence on stock prices. Almost all of the results are

clear. The results show evidence of positive sto ck returns

as central bank independence improves; most notably,

economic independence of the central bank is more im-

portant than political independence. However, these re-

sults could not be found for developing and emerging

Table 3. (a) Granger causality test: Total countries. (b)

Granger causality test: Developed countries; (c) Granger

causality test: Developing and emerging countrie s.

(a)

F-statistic Prob.

Central bank independence does not

Granger cause stock return 0.08 0.77

Stock does not Granger cause

central bank independence 0.34 0.56

(b)

F-statistic Prob.

Central bank independence does not

Granger cause stock return 5.86 0.006

Stock does not Granger cause

central bank independence 1.95 0.16

(c)

F-statistic Prob.

Central bank independence does not

Granger cause stock return 1.72 0.20

Stock does not Granger cause

central bank independence 4.50 0.08

economies. The empirical results show strongly the ef-

fects of the independence of central banks along with the

differences among countries, regions, and so on.

The political aspect of central b ank independence does

not appear to exert a strong influence on stock returns.

Other aspects should be considered carefully and taken

into account. [15] showed that leftist governments had

somewhat lower interest rates than right-wing govern-

ments when central bank independence is low. [16] also

showed that high central bank independence may require

a high level of conservatism. There is much room for

discussion.

5. Acknowledgements

We appreciate a referee’s comments and suggestions.

REFERENCES

[1] T. Förch and U. Sunde, “Central Bank Independence and

Stock Market Returns in Emerging Economies,” Eco-

nomics Letters, Vol. 115, No. 1, 2012, pp. 77-80.

doi:10.1016/j.econlet.2011.11.030

[2] Y. Kurihara, “Inflation Targeting and the Role of the Ex-

change Rate: The Case of the Czech Republic,” Interna-

tional Business Research, Vol. 5, No. 3, 2012, pp. 33-39.

doi:10.5539/ibr.v5n3p33

[3] J. Forder, “Why Is Central Bank Independence So Widely

Approved?” Journal of Economic Issues, Vol. 39, No. 4,

2005, pp. 843-865.

[4] C. T. Carlstorm and T. S. Fuerst, “Central Bank Inde-

Y. KURIHARA ET AL.

797

pendence and Inflation: A Note,” Economic Inquiry, Vol.

47, No. 1, 2009, pp. 182-186.

[5] G. Petrevski, J. Bogoev and B. S. Sergi, “The Link be-

tween Central Bank Independence and Inflation in Cen-

tral and Eastern Europe: Are the Results Sensitive to En-

dogeneity Issue Omitted Dy namics and Subjectivity Bias?”

Journal of Post Keynesian Economics, Vol. 34, No. 4,

2012, pp. 611-621. doi:10.2753/PKE0160-3477340403

[6] C. Hefe ker and B. Zimmer, “The Optimal Choice of Cen-

tral Bank Independence and Conservatism under Uncer-

tainty,” Journal of Macroeconomics, Vol. 33, No. 4, 2011,

pp. 595-615. doi:10.1016/j.jmacro.2011.09.005

[7] A. Alesina and A. Summers, “Central Bank Independence

and Macroeconomic Performance: Some Comparative

Evidence,” Journal of Money, Credit and Banking, Vol.

25, No. 2, 1993, pp. 151-162. doi:10.2307/2077833

[8] B. Neyapti, “Central Bank Independence and Economic

Performance in Eastern Europe,” Economic Systems, Vol.

25, No. 4, 2001, pp. 381-399.

doi:10.1016/S0939-3625(01)00033-4

[9] M. Arnone, B. J. Laurens and J.-F. Segelotto, “Central

Bank Autonomy: Lessons from Global Trends,” IMF

Working Paper, No. 88, 2009. doi:10.1057/imfsp.2008.25

[10] K. N. Kuttner and A. S. Posen, “Do Markets Care Who

Chairs the Central Bank,” Journal of Money, Credit, and

Banking, Vol. 42, No. 2, 2010, pp. 347-371.

[11] M. Fry, D. Julius, L. Mahadeva, S. Roger and G. Ssterne,

“Key Issues in the Choice of Monetary Policy Frame-

work,” In: J. Mahadeva and S. Sterne, Eds., Monetary

Policy Frameworks in a Global Context, Rou tledge , Lon-

don, 2000, pp. 50-66.

[12] C. Moser and A. Dreher, “Do Markets Care about Central

Bank Governor Changes? Evidence from Emerging Mar-

kets,” Journal of Money, Credit and Banking, Vol. 42, No.

5, 2010, pp. 1589-1612.

doi:10.1111/j.1538-4616.2010.00355.x

[13] A. Cukierman, A, Webb and S. Neyapti, “Measuring the

Independence of Central Banks and Its Effects on Policy

Outcomes,” World Bank Economic Review, Vol. 6, No. 3,

1992, pp. 353-398. doi:10.1093/wber/6.3.353

[14] C. J. Hueng, “Central Bank Behavior and Statutory In-

dependence,” Atlantic Economic Journal, Vol. 40, No. 2,

2012, pp. 111-126. doi:10.1007/s11293-012-9310-x

[15] A. Belke and N. Potrafke, “Does Government Ideology

Matter in Monetary Policy? A Panel Data Analysis for

OECD Countries,” Journal of International Money and

Finance, Vol. 31, No. 5, 2012, pp. 1126-1150.

[16] H. Feldmann, “Central Bank Independence, Wage Bar-

gaining, and Labor market Performance: New Evidence,”

Southern Economic Journal, Vol. 77, No. 3, 2011, pp.

692-725. doi:10.4284/sej.2011.77.3.692