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The Measure of Financial Regulators’ Independence

The benefits of central bank independence are accepted by almost everyone nowadays. And there is growing evidence that financial regulation works best – boosting the stability of the banking system – when regulators and supervisors have similar independence.

LONDON – There is a vast academic literature on central bank independence, and central bank governors address the topic at every opportunity. Most of the academic papers, and all of the governors, argue that a high degree of independence is associated with low inflation and monetary stability.

Some of these academic studies question the direction of causation, asking whether countries with highly inflation-averse populations – Germany being the most obvious example – are inclined to favor robust independence. But there is wide support for the general proposition that taking politicians out of the process of setting interest rates is associated with lower and more stable inflation. There is much evidence that, previously, the electoral cycle influenced interest-rate decisions, with damaging consequences.

Much less attention has been paid to the independence of financial regulators and, especially, banking supervisors. Many of the latter are of course part of central banks, but by no means all of them are.

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