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INDEPENDENCE DAY FOR THE ‘OLD LADY’: A NATURAL EXPERIMENT ON THE IMPLICATIONS OF CENTRAL BANK INDEPENDENCE

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Abstract:

Central bank independence is widely thought be a sine qua non of a credible commitment to price stability. The surprise decision by the UK government to grant operational independence to the Bank of England in 1997 affords us a natural experiment with which to gauge the impact on the yield curve from the adoption of central bank independence. We document the extent to which the decision to grant independence was ‘news’ and illustrate that the reduction in medium- and long-term nominal interest rates was some 50 basis points, which we show to be consistent with a sharp increase in policy-maker's aversion to inflation deviations from target. We therefore suggest that central bank independence represents one of the clearest signals available to elected politicians about their preferences on the control of inflation.

Document Type: Research Article

DOI: https://doi.org/10.1111/j.1467-9957.2007.01019.x

Affiliations: 1: BNP Paribas 2: University of St Andrews

Publication date: 2007-06-01

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