3/2017 Gregory Levieuge, Yannick Lucotte and Florian Pradines-Jobet. Central banks’ preferences and banking sector vulnerability


Working Papers of Eesti Pank 3/2017

According to "Schwartz’s conventional wisdom" and what has been called "divine coincidence", price stability should imply macroeconomic and financial stability. However, in light of the recent financial crisis, with monetary policy focused on price stability, scholars have held that banking and financial risks were largely unaddressed. According to this alternative view, the belief in divine coincidence turns out to be benign neglect. The objective of this paper is to test Schwartz’s hypothesis against the benign neglect hypothesis. The priority assigned to the inflation goal is proxied by the central banks’ conservatism (CBC) index proposed by Levieuge and Lucotte (2014b), here extended to a large sample of 73 countries from 1980 to 2012. Banking sector vulnerability is measured by six alternative indicators that are frequently employed in the literature on early warning systems. Our results indicate that differences in monetary policy preferences robustly explain cross-country differences in banking vulnerability and validate the benign neglect hypothesis, in that a higher level of CBC implies a more vulnerable banking sector.

DOI: 10.23656/25045520/32017/0141

JEL Codes: E3; E44; E52; E58

Keywords: central banks’ preferences, inflation aversion, banking sector vulnerability, monetary policy

Corresponding author’s e-mail address: gregory.levieuge [at] univ-orleans.fr

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The views expressed are those of the authors and do not necessarily represent the official views of the Eesti Pank or the Eurosystem.