Central Bank Independence and Sovereign Borrowing

Abstract

This paper studies the impact of central bank independence on sovereign borrowing, using an index that captures institutional constraints on central bank lending to the government across 155 countries from 1972 to 2023. The findings show that tighter lending to the executive significantly reduces sovereign interest rates and raises the debt-to-gross domestic product ratio in developing countries. These effects reflect the executive’s improved ability to borrow at lower costs under greater central bank independence. The results are robust to multiple tests, but there are no significant effects in advanced economies. From a policy perspective, the results highlight the key role of independent central banks as catalysts for reducing governments’ borrowing costs and enhancing the government’s borrowing capacity.