Central Bank Independence and Fiscal Stance: The Role of Institutions in Supporting Fiscal Sustainability

ABSTRACT We investigate the effect of central bank independence (CBI) on fiscal stance: the direct impact on the primary balance and the impact on the reaction of the primary balance to the public debt. We also analyze the role of institutions in the effects of CBI on fiscal policy. We estimate fiscal reaction functions augmented by a measure of CBI using a panel of 98 countries. We find that CBI lowers the primary balance but strengthens its reaction to the government debt, hence increasing long‐term fiscal sustainability. Other institutions, such as democracy, seem to strengthen the negative direct reaction of the primary balance to CBI.