International Finance and Central Bank Independence: Institutional Diffusion and the Flow and Cost of Capital

Research on central bank independence (CBI) focuses overwhelmingly on domestic causes and consequences. We consider CBI in relation to global finance. A first step links decisions to reform central bank legislation to a perceived need to attract capital in the form of foreign direct investment or sovereign borrowing. A second step models investors’ actual decisions as a function of CBI. We test our argument on a sample of 78 countries (1974–2007). Logit models investigate the determinants of central bank reform. Results show the effect of international capital through a direct-competition channel and through learning in the context of competition. Socialization of countries in networks of intergovernmental organizations is also a determinant of CBI reform. In addition, we show that CBI affects the flow and cost of capital in non-OECD countries, before CBI became globally widespread, and where political institutions allow the central bank to de facto be credible.