Democratic Backsliding and Central Bank Independence

• In Event: The Political Economy of Democratic Backsliding

Abstract

A number of emerging economies have witnessed a concerning trend of central banks facing threats to their political independence, as seen in recent cases in Turkey, India, and Israel. Notable is that these instances coincided with periods of democratic decay in the respective countries, implying a potential association between democratic backsliding and central bank independence (CBI).

This paper leverages existing scholarship on political regimes, highlighting the tendency of backsliding governments to prioritize narrow interests over public goods. The literature suggests that backsliding increases the government's proclivity to cater to the particularistic interests of its narrow support coalition. Abundant financial resources at their discretion should help backsliding political leaders serve this purpose. Independent central banks with a strong mandate for price stability stands out as an impediment to such pursuits. Backsliding leaders, therefore, are inclined to undermine CBI.

Despite the intuitive appeal and theoretical grounding of this argument, systematic research directly connecting democratic backsliding and CBI remains rare. Addressing this lacuna, the paper posits that central banks in countries experiencing democratic backsliding are more likely to suffer declines in their political independence compared to their counterparts in non-backsliding countries. To test this hypothesis, a panel data set featuring V-dem's Episode of Regime Transformation (ERT) data as the treatment variable and Garriga's (2016) Central Bank Independence in the World data as the outcome variable is employed. Using a staggered difference-in-difference design, empirical evidence in support of the argument and robust to alternative empirical scenarios is presented.

The findings of this research contribute significantly to our understanding of the effect of dynamic changes in political institutions on the functions of economic ones. The paper also adds to the burgeoning literature that points to the negative material consequences democratic backsliding generates. Backsliding is concerning not only because of its normative implications ('democracy under attack') but also because of its destabilizing effect on the economy.

Author

• Byunghwan Son, George Mason University