Central Bank and national macroeconomic performance: Before and after external governance and sovereign credit ratings

Erik C Dellith, Fordham University


Given the strong links between macroeconomic policy, especially inflation, and economic growth and financial stability, economists, regulatory agencies and credit rating agencies have put a great deal of effort into measuring the quality of policy making. In particular the large Central Bank governance literature has attempted to document the various "pillars" of central bank performance: credibility, transparency, independence, etc. The World Bank, the IMF and some NGOs now also publish policy rankings. And given the rising importance of private capital flows to emerging and frontier markets, private credit rating agencies have begun rating developing country governments as well. How do these ratings affect future macroeconomic performance? If high rankings are a reward for good performance, Central Banks for example may gain credibility or autonomy after receiving high ratings or ranking, creating a virtuous circle of good ratings leading to good performance. Alternatively, good luck may be followed by bad and performance may regress toward the mean. This research builds on the work of Rogoff (1985) and Walsh (1995) who posit central bank objective functions that reward or punish good performance. To the extent that high performance rankings extend the terms of or give Central Bank governors more autonomy a virtuous circle may emerge. Of course, high ratings may also increase access to credit or lower borrowing costs, so improved performance must be conditional on other factors. This research explores the impact of CB governance, World Bank CPIA, Ibrahim Foundation rankings in Africa and private Fitch Ratings on future economic performance, especially inflation. We examine the effectiveness of these different ranking systems to predict macroeconomic performance and test for the existence of a virtuous cycle, where favorable performance leads to better ratings, which, in turn, lead to better performance. Among the CB governance indices, credibility generally predicts inflation. Controlling for per capita income and financial depth, evidence suggests that independence, transparency, and credibility matter for average per capita growth among OECD countries. Of the five World Bank Country Policy and Institutional Assessment only the Financial Sector Rating yields a virtuous circle with respect to economic growth. We also examine the reasons a good FSR ratings leads to economic growth, one reason is that both the FSR and Macroeconomic Management Rating create a virtuous cycle with inflation. With respect to the Fitch Sovereign credit ratings, we find a virtuous circle for both growth and inflation among OECD economies, but only for per capita growth among emerging market countries. Research suggests that the transmission mechanism for this virtuous cycle to be the reduced costs of external borrowing and greater private capital inflows, but these exact dynamics require further research.

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Recommended Citation

Dellith, Erik C, "Central Bank and national macroeconomic performance: Before and after external governance and sovereign credit ratings" (2012). ETD Collection for Fordham University. AAI3542749.