Central bank independence and stock market returns in developed countries

ABSTRACT

Central bank independence (CBI) is seen in the literature and by policy-makers as being important for achieving stability of inflation and long-term welfare. However, relatively few studies directly consider the relationship between CBI and stock market returns. Using a set of 21 developed countries, over a period of 20 years, and the Morgan Stanley Capital International indices, we test the impact caused by the levels of independence of countries’ central banks. The results lead us to conclude that the ‘free lunch’ hypothesis behind CBI cannot be rejected when its impact on stock market returns is considered.

KEYWORDS:

• Central banks
• panel data
• independence
• stock markets

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. To measure stock returns, the authors use $\mathrm{S}\mathrm{M}{\mathrm{R}}_{it}=\frac{\mathrm{M}\mathrm{S}\mathrm{C}{\mathrm{I}}_{it}-\mathrm{M}\mathrm{S}\mathrm{C}{\mathrm{I}}_{it-1}}{\mathrm{M}\mathrm{S}\mathrm{C}{\mathrm{I}}_{it-1}}$, where SMR_it is the return for a given period t (in months) using the 27 MSCI Emerging Stock Index countries (i).

2. Fixed effects is the most used model to test for changes in policy measures and its impact. On the other hand, stationarity seems to be neglected in most empirical applications. We widen the econometrical analysis and introduce these concerns, and by so doing, try to verify whether the results are robust.

3. To choose the number of lags to adjust for serial correlation, the Akaike information criterion (AIC) is used, as this is best for a small sample. The adjustment was also made using the other two information criteria and the conclusions did not change.