Earthquakes and Economic Outcomes: Does Central Bank Independence Matter?
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Earthquakes and Economic Outcomes: Does Central Bank Independence Matter? Jeroen Klomp 1,2 & John Sseruyange 3 # The Author(s) 2020
Abstract This study explores whether the degree of central bank independence influences the economic performance in the period immediately following an earthquake. Earthquakes create a classic monetary policy challenge: how to accommodate the real shock in the short run with the objective of low inflation. The ultimate outcome of this dilemma depends for a large part on the degree of delegation of the monetary powers to an independent central bank and the inflation averseness of the central bank governors. Our main empirical findings clearly indicate that the increase in the inflation rate after an earthquake is significantly smaller when monetary policy is conducted by a more independent central bank. At the same time, countries with an independent central bank are confronted with a wider output gap after an earthquake suggesting a slower economic recovery. Keywords Output gap . Inflation . Central Bank Independence . Earthquakes JEL Codes E52 . E58 . E3 . Q54
1 Introduction One of the main global challenges for sustainable economic development in the next decade is to limit the economic consequences of large-scale natural disasters. Since the 1970s, the damage-related costs of these events have risen dramatically. Record losses of some US$380 billion were recorded in 2011, the year of the Tohoku earthquake in
* Jeroen Klomp [email protected]
1
Faculty of Military Sciences, Netherlands Defence Academy, Breda, The Netherlands
2
Section Economics, Wageningen University & Research, P.O. Box 8130, 6700 EWWageningen, The Netherlands
3
Makerere University, Kampala, Uganda
Klomp J., Sseruyange J.
Japan, equivalent to 0.9% of global GDP (Guha-Sapir et al. 2015). It is widely documented in the previous literature that these catastrophes put the short-run macroeconomic performance of many countries mainly under considerable downward pressure since they will severely hit countries’ economic growth rates, their external performance, price level, financial system, and fiscal sustainability (see among others Felbermayr and Grösch, 2014; Skidmore and Toya 2002; Noy 2009; Loayza et al. 2012; Lis and Nickel 2009; Noy and Nualsri 2011; Gassebner et al. 2010; Oh and Reuveny 2010; Klomp 2017; Wang 2017). Because natural disasters seriously challenge the economic performance of a country, it is expected that these events will influence the monetary policy decisions made by the central bank. The most important aim of the monetary authorities in the period after a natural disaster is to stabilize the economy again. However, there is only one concern since natural disasters create a classic monetary policy challenge: how to accommodate the real shock in the short run with the objective of anchoring inflation when these two competing objectives demand opposite policy actions. On the one hand, natural disasters cause a shortfall in the output produced, leading to a temporary negative
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