Central bank independence and fiscal discipline: A Panel GMM analysis within the framework of institutional quality and democracy in inflation targeting countries

Central bank independence (CBI) is widely regarded as a crucial tool for ensuring economic stability and fiscal discipline. This study examines the impact of CBI on fiscal discipline using panel data from 29 countries practicing inflation targeting, employing the System GMM method, and considering the roles of institutional quality and democracy. To measure CBI, two widely used indices in the literature—Grilli, Masciandaro, and Tabellini (GMT) and Cukierman, Webb, and Neyapti (CWN)—are employed. The results indicate that CBI alone does not provide a significant contribution to fiscal discipline and may even have adverse effects under conditions of low institutional quality or weak democratic frameworks. However, when interactions with institutional quality indicators (such as rule of law, control of corruption, and government effectiveness) and democracy levels are considered, the impact of CBI on fiscal discipline becomes positive and statistically significant. Marginal effects analysis supports and visualizes these findings. When institutional quality is low, the effect of CBI is weak or negative, whereas higher institutional quality strengthens its contribution to fiscal discipline. Similarly, when democracy levels are low, the effect of independence is limited, but it becomes significant for Combined Polity Scores of approximately 6.5 and above. These results emphasize that the effectiveness of CBI emerges not solely through legal provisions but in conjunction with strong institutional reforms and democratic oversight mechanisms. Accordingly, policymakers should consider enhancing central bank independence in a coordinated manner with institutional quality and democracy to ensure robust fiscal discipline