Modern Economy, 2012, 3, 793-797 Published Online October 2012 (
Central Bank’s Independence and Stock Prices
Yutaka Kurihara1, Koichiro Morikawa2, Sadayoshi Takaya3
1Faculty of Economics, Aichi University, Nagoya, Japan
2Faculty of Economics, Kinki University, Higashiosaka , Japan
3Faculty of Commerce, Kansai University, Suita, Japan
Received September 13, 2012; revised October 13, 2012; accepted October 20, 2012
Since the end of 1990s, the independence of central bank independence has been discussed. In the past, central banks
tried to improve their independence to combat inflation. This independence has been evaluated relative to adequate
economic policy and stable economic growth. This article examines the effect of central bank independence on stock
market prices and finds evidence for a positive return in developed coun tries; moreover, for stock prices, economic in-
dependence of the central bank seems to be more important than political independence.
Keywords: Central Bank Independence; Mone tary Policy; Stock Price
1. Introduction
An independent central bank is considered necessary for
the conduct of credible monetary policy that is com-
mitted to maintain stab le inflation [1]. On the o ther hand,
central banks are responsible for the conduct of monetary
policy and output [2]. Many studies have noted that
higher degrees of central bank independence can keep
inflation stable [3,4]. On the other hand, [5] showed that
the negative relationship between central bank inde-
pendence and inflation could not be found by examining
the effects on some macroeconomic and institutional
variables. As noted in these studies, there is much room
for the role of central bank independence to influence for
market performance. This article provides evidence that
focuses on the question of whether a greater degree of
central bank independence results in greater stock re-
One serious problem exists in this area: very limited
data are available regarding reliable central bank inde-
pendence. Only a few studies have provided this type of
data. [4] compared Alestina and Summers’s data with
those of [6] and found a large increase in central bank
independence. To collect the same data and link different
time data in one series is difficult. To make a central
bank index based on these analyses is still more difficult
because the data are sometimes limited. Also, reliable
data based full on the past is almost impossible. Some
possibility exists that different situations may have im-
pacted the determination of central bank independence.
On the other hand, a few studies have been evaluated
highly and cited often. Moreover, the use of data for em-
pirical analysis sometimes causes problems as these es-
tablished papers provide fixed data for some sample
This article contributes to the limited literature that
goes beyond the effects of central bank independence on
inflation ([7-9]). [10] focused on the effects of central
bank independence on exchange rates. [11] found that
central bank independence favorably affected employ-
ment rates. However, as there has been little reliable and
broadly accepted data for central bank independence,
especially for the recent period, the need to analyze the
relationship between central bank independence and eco-
nomic variables has increased. This article responds to
this need.
[11] stated that an independent central bank fosters
stock market returns by constraining inflation. [12,13]
investigated the effect of central bank independence on
stock market in emerging economies. The former found
that high government turnover has a negative effect on
stock market returns. The latter indexed central bank
independence index into two categories (i.e., economic
and political) and found evidence for a positive return;
however, the economic independence of the central bank
seems to be more important than political independence
in developing and emerging countries.
However, few studies have considered central bank
independence relative to many countries, the recent pe-
riod, and the effects of central bank independence on
macroeconomic variables. Few studies have assessed the
relationship between stock prices and macroeconomic
This article examines empirically the effects of central
opyright © 2012 SciRes. ME
bank independence on stock prices as well as the effects
of some macroeconomic variables on stock prices. The
central bank independence index is drawn from two fa-
mous ones [1,13], which have been cited frequently. Two
groups of countries area used for this analysis: dev eloped
economies and developing/emerging economies. A com-
parison of these categories seems very important for the
conduct of monetary policy and for stable growth. Al-
though the ideal would be to use a reliable central bank
index, it is difficult to collect this type of data. Two reli-
able data [9,13] are employed in this article. However,
political and economic elements of the two indices are
distinguished to analyze the effects of the central bank
independence and some economic variables on stock
2. Theoretical Analysis
This article empirically examines the effect of central
bank independence and economic variables on stock
market prices. The equation for the empirical analysis is
as follows:
STOCKit = Const + αCBIit + βXit + εit (1)
STOCK means year-to-year p ercentage change of stock
prices. CBI denotes central bank independence index. X
means four macroeconomic variables related to stock
prices (explained in 3-1 in detail). i denotes country and t
means time. This equation is orthodox and not new as
based on [1]. Both the effect of CBI effect on stock
prices and some related macroeconomic variables with
stock prices and goals of central banks are added as ex-
planation variables for empirical estimation. This equa-
tion is orthodox and not new as based on [1].
The effect of CBI on stock prices is the main focus of
this article; it cannot be omitted. Second, almost all of
the central banks conduct their policies to attain stable
inflation rates. Inflation rate should be examined. Third,
interest rate is the most important factor for determina-
tion of stock prices. It is added as an explanation variable.
Fourth, as most central banks are interested in economic
growth, GDP growth is used as an explanation variable.
Finally, export growth is added as an explanation vari-
able as per [1], because not only the cases of developed
but also those of emerging and developed countries are
employed for estimation. Some developing and emerging
economics depend on exports for economic growth, na-
mely, in stock prices.
The main interest is in the effects of CBI on stock
prices. The CBI indices used here are the Cukierman and
Arnone index of the subindices for political independ-
ence and economic independence, together and in total.
All measures of CBI are measured for the period for
which the returns are calculated. Changes do not always
represent permanent shifts in the level of the CBI proxy.
3. Empirical Method and Results
3.1. Empirical Method
The data are yearly. For central bank independence, the
data derived from [9,13] are both used. The two papers
provided data regarding central bank independence; all
data are fixed. The sample periods are from 1989 to 1992
for the index of [13] and from 2005 to 2007 for the index
of [9]. These indices are based on information about cen-
tral bank independence across 10 dimensions. [9,13] are
combined with different weights in an economic and
political independence index. Both economic and politi-
cal factors are taken into account.
[14] found that the differences in behaviors among
central banks are consistent with the economic measure
of independence, which measures how easy it is for the
government to finance its deficits by direct access to
credit from the central bank. For example, one of the
economic differences is whether or not the central bank
is obliged to finance government debt, and one of the
political differences is the relationship between the cen-
tral bank and the government in determining monetary
policy. Both economic and political elements should be
considered in determining the central bank index.
This article divides the countries into two groups: 1)
developed countries and 2) developing or emerging
countries. For developed countries, the countries esti-
mated are Australia, Austria, Belgium, Korea, Nether-
lands, New Zealand, Norway, Portugal, Singapore, Spain,
Sweden, Switzerland, the United Kingdom, and the Uni-
ted States. Developing and emerging economies include
Barbados, Columbia, Israel, Malta, Peru, Philippines,
South Africa, Turkey, and Venezuela. Only the countries
selected were examined in this analysis due to the data
The stock market prices are percentage year-to-year
change and are used for dependent variables. Explana-
tory variables include the index of central bank inde-
pendence, inflation, GDP growth, export growth, and in-
terest rate. All of the data except the index of central
bank independence are percentage year-to-year change
and are from International Financial Statistics (Interna-
tional Monetary Fund). Three indices are used for central
bank independence: total, economic, and political.
It is necessary to check unit root tests for estimation.
This paper uses two typical methods: augmented Dickey-
Fuller (ADF) and Phillips-Perron (PP). ADF is most used
for empirical estimation; however, if the series is corre-
lated at higher order lags, the assumption of white noise
disturbances is violated. The PP test proposes a method
by which to control for higher order serial correlation in
a series than is accepted in the equation. The test makes a
Copyright © 2012 SciRes. ME
nonparametric correction to the t-test statistic. This is
robust with respect to unspecified autocorrelation and
heteroscedasticity in the disturbance process of the test
The results of two methods explained are in Tables
1(a)-(c). In a few cases, the results are mixed and are not
perfectly conclusive. However, almost all of the results
are not problematic for empirical estimations.
3.2. Empirical Results
The results of the equation (1) are shown in Tables 2(a)-
(c). The regression method is OLS (ordinary least squa-
The results are clear. Central bank independence has
positive impact on stock prices in general. However, the
results show that it is necessary to distinguish developed
countries from other countrie s. The results show positive
evidence that central bank independence increases stock
Table 1. (a) Unit root test: Total countries; (b) Unit root test:
Developed countries; (c) Unit root test: De ve loping and emer-
ging countries.
Stock return –3.20*** –52.80***
Inflation 0.23 –62.89***
GDP growth –3.36*** –20.89***
Export growth –3.03** –48.12***
Interest rate –0.37 –63.14***
Stock return –3.24*** –47.02***
Inflation –2.43** –32.61***
GDP growth –3.93*** –40.28***
Export growth –1.63* –59.36***
Interest rate –2.60** –32.47***
Stock return –2.46** –17.88***
Inflation –2.37** –16.16***
GDP growth –2.04** –18.22***
Export growth –3.88*** –9.69***
Interest rate –2.44** –10.37***
Note. ***means significant at 1%, **means at 5%, a nd *means at 10% level.
Table 2. (a) Effects of central bank independence on stock
returns: Total countries; (b) Effects of central bank inde-
pendence on stock re turns: Developed countries; (c) Effects
of central bank independence on stock returns: Developing
and emerging countries.
(a) Central bank independence
Variable Political Economic Total
C –20.75
(–1.61) –41.89**
(–2.71) –44.48**
Stock return (–1) 0.47
(2.79) 0.41**
(2.53) 0.47**
Central bank independence42.06**
(2.75) 54.72***
(3.58) 70.91***
Inflation rate 2.73***
(19.36) 0.14***
(19.87) 2.67***
GDP growth –0.78
(–0.51) –0.55
(–0.37) –0.07
Export growth 0.15
(0.28) 0.50
(1.00) 0.18
Interest rate –0.14
(–0.26) 0.06
(0.16) 0.15
Adj.R2 0.99 0.99 0.99
F-statistic 15170.83 16409.09 17142.20
Durbin Watson 2.40 2.32 2. 2 8
(b) Central bank independence
Variable Political EconomicTotal
C 9.61
(1.19) –9.18
(–0.79) –1.79
Stock return (–1) 0.32**
(2.88) 0.37***
(3.47) 0.36**
Central bank independence 0.62
(0.08) 18.22**
(1.96) 14.47
Inflation rate –1.85
(–1.34) –1.23
(–0.93) –1.30
GDP growth –2.34**
(–2.21) –1.70*
(–1.60) –1.84*
Export growth 1.42***
(4.10) 1.53***
(4.84) 1.37***
Interest rate –0.88
(–1.19) –0.70
(–0.99) –0.87
Adj.R2 0.93 0.98 0.95
F-statistic 9.20 10.79 9.79
Durbin Watson 1.62 1.64 1.64
(c) Central bank independence
Variable Political EconomicTotal
C –24.53
(–0.81) –31.51
(–0.89) –36.48
Stock return (–1) 0.53
(1.47) 0.44
(1.33) 0.43
Central bank independence 74.50
(1.15) 48.03
(1.00) 80.86
Inflation rate 2.58***
(8.58) 2.55***
(8.51) 2.59***
GDP growth 2.13
(0.75) 2.04
(0.66) 2.12
Export growth –1.13
(–1.02) –0.93
(–0.84) –1.05
Interest rate 0.49
(0.43) 0.71
(0.64) 0.57
Adj.R2 0.99 0.99 0.99
F-statistic* total 5970.871 5846.20 6011.03
Durbin Watson* total 2.34 2.34 2.38
Note. *** means significant at 1%, ** means at 5%, and * means at 10% level.
Copyright © 2012 SciRes. ME
prices for developed economies, however, the relation-
ship cannot be found for developing and emerging eco-
nomies. Also, there is large difference between the usage
of the political element and the econ omic element.
All of the coefficients of central bank independence on
stock prices are positive and significant for developed
economies. However, only the economic indices are sig-
nificant. The effects of inflation on stock prices reflect
the results that adj. R2s are small in Table 2(b). For the
case of developing and emerging economies, the coeffi-
cients are positive as expected; however, not all of them
are significant.
The results show strongly that it would be dangerous
to state that improvements in central bank independence
cause stock prices to rise. Considering economic condi-
tions/stages and elements of central bank independence
would be necessary for policymakers to attain economic
development. Also, economic elements of central bank
independence should be carefully examined. Systematic
and reasonable policy for economic development to fit
each economy would be necessary and important.
It is interesting to note th at exporting growth promotes
stock price rising in developed countries (but not in de-
veloping and emerging economies). GDP growth is not
necessarily linked to increases in stock prices. In devel-
oping and emerging economies, inflation promotes in-
creased stock prices. Deflation and domestic demand
have been serious in developed economies, which may
have some effect on these results.
Also, it is interesting to note that central bank inde-
pendence increases inflation for developing and emerg-
ing economies. The reason is difficult to understand.
There is some possibility that central banks which have
high independence do not strong emphasis on inflation.
Also, inflation may be caused by other factors such as
asset prices.
The Granger causality test was performed to check the
hypothesis (see Tables 3(a)-(c)). The Granger causality
test is a statistical hypothesis test that de termines wh eth er
a time series is useful for forecasting. A time series X is
said to Granger cause Y if it can be shown in a serious of
F tests on lagged values of X and that those X values
provide significant data about future values of Y.
The results show positive evidence that central bank
independence increases stock prices.
4. Conclusions
This article examined the effects of central bank inde-
pendence on stock prices. Almost all of the results are
clear. The results show evidence of positive sto ck returns
as central bank independence improves; most notably,
economic independence of the central bank is more im-
portant than political independence. However, these re-
sults could not be found for developing and emerging
Table 3. (a) Granger causality test: Total countries. (b)
Granger causality test: Developed countries; (c) Granger
causality test: Developing and emerging countrie s.
F-statistic Prob.
Central bank independence does not
Granger cause stock return 0.08 0.77
Stock does not Granger cause
central bank independence 0.34 0.56
F-statistic Prob.
Central bank independence does not
Granger cause stock return 5.86 0.006
Stock does not Granger cause
central bank independence 1.95 0.16
F-statistic Prob.
Central bank independence does not
Granger cause stock return 1.72 0.20
Stock does not Granger cause
central bank independence 4.50 0.08
economies. The empirical results show strongly the ef-
fects of the independence of central banks along with the
differences among countries, regions, and so on.
The political aspect of central b ank independence does
not appear to exert a strong influence on stock returns.
Other aspects should be considered carefully and taken
into account. [15] showed that leftist governments had
somewhat lower interest rates than right-wing govern-
ments when central bank independence is low. [16] also
showed that high central bank independence may require
a high level of conservatism. There is much room for
5. Acknowledgements
We appreciate a referee’s comments and suggestions.
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