Measuring Shocks to Central Bank Independence using Legal Rulings

TL;DR

This paper examines how legal rulings against the European Central Bank influence monetary policy and financial markets, revealing significant impacts on financial conditions and inflation expectations.

Contribution

It introduces an econometric approach to measure the effects of legal challenges on central bank independence and monetary policy conduct.

Findings

Legal rulings significantly impact financial markets.

Expansionary shocks improve financial conditions.

Short-term inflation expectations are affected.

Abstract

We investigate the consequences of legal rulings on the conduct of monetary policy. Several unconventional monetary policy measures of the European Central Bank have come under scrutiny before national courts and the European Court of Justice. These lawsuits have the potential to severely impact the scope and flexibility of central bank policies, and central bank independence in a wide sense, with important consequences for the real and financial economy. Since the number of relevant legal challenges is small, we develop an econometric approach that searches for minimum variance regimes which we use to isolate and measure the effects of these events. Our results suggest that legal rulings addressing central bank policies have a powerful effect on financial markets. Expansionary shocks ease financial conditions along various dimensions, and inflation swap reactions suggest inflationary pressures with stronger effects in the short term.