The Effect of Financial Regulation Mandate on Inflation Bias: A Dynamic Panel Approach

Central banks in charge of banking regulation are less aggressive in their inflation mandate since tight monetary policy conditions could have an adverse effect on the stability of the banking system. Due to the conflict between the two mandates, it has been argued that banking supervisory powers should be assigned to an independent authority to avoid ination bias and enhance social welfare. The rst part of the paper develops a theoretical model that assesses the interaction between different policy transmission channels, namely the credit channel and the banks' balance sheet channel. Focusing on a mandate where central banks are also responsible for banking supervision, cases where the price and financial stabilisation objectives are complementary or conflicting are identfied, highlighting the role of policy instruments and types of macroeconomic shocks on welfare. The second part of the paper empirically assesses whether central banks' combined mandates lead to an inflation bias problem using panel data for 25 industrialised countries from 1975 to 2012. The estimation results show that, once we control for relevant policy and institutional factors (such as the presence of inflation targeting and deposit insurance schemes), the separation of banking supervision and monetary policy does not have a significant effect on inflation outcomes.