Monetary Policy and Banking Supervision: Is There a Conflict of Interest?

The objective of this paper is to empirically assess whether central banks are less aggressive in their inflation mandate when they are in charge of banking regulation, since tight monetary policy conditions could have an adverse effect on the stability of the banking system. Due to this conflict of interest between the monet ary policy makers and bank regulators, it has been argued that banking supervisory powers should be assigned to an independent authority to avoid an inflation bias. We perform an econometric analysis using panel data for 25 industrialised countries from 1975 to 2007 to analyse the impact of a country’s institutional mandate of monetary policy and banking supervision on inflation outcomes. Using a fixed effects approach, the estimat ion results obtained do not provide evidence to suggest that separation of banking supervision and monetary policy has a significant effect on inflation outcomes. Nevertheless , results show that other institutional factors, such as inflation targeting and deposit in surance schemes, are significant determinants of inflation outcomes.