How Do Central Bank Governors Matter? Regulation and the Financial Sector

• Published date: 01 March 2019
• Author: PRACHI MISHRA,ARIELL RESHEF
• Date: 01 March 2019
• DOI: http://doi.org/10.1111/jmcb.12578

DOI: 10.1111/jmcb.12578

PRACHI MISHRA

ARIELL RESHEF

How Do Central Bank Governors Matter?

Regulation and the Financial Sector

Do past employment characteristics of central bank governors affect finan-

cial regulation? To answer this question, we construct a newdata set based

on curriculum vitae of all central bank governors around the world in 1970–

2011. We interpret work experiences as indicators of preferences toward

deregulation. Over the average duration in office (5.6 years), a governor

with financial sector experience is associated with three times more dereg-

ulation than a governor without experience in finance. Similar results hold

for past experience at the IMF; in contrast, past experience at the BIS and

the UN are associated with less deregulation.

JEL codes: E58, G28

Keywords: central bank, central bank governor, leaders,

financial regulation.

CENTRAL BANK GOVERNORS (PRESIDENTS OR chairmen) play a

pivotal role in decisions about economic policy,even when they are part of a board or

committee, and even when central banks are not fully independent. For example, in

his role as chairman of the Board of Governors of the Federal Reserve, Paul Volcker

is famously responsible for changing the conduct of monetary policy in the United

States in the 1980s. Volcker’s credibility, bolstered by his experience in the financial

sector and the U.S. Treasury Department, waskey for his success in reducing inflation.

We thank George Akerlof, Olivier Blanchard, Stanley Fischer, Kenneth Kuttner, David Romer, par-

ticipants at the IMF Research Brown Bag Seminar, the editor, and two anonymous referees for useful

comments and suggestions. Reshef thanks the Bankard Fund for Political Economy, the Officeof the Vice

President for Research, and the College of Arts and Sciences at the Universityof Virginia for financial sup-

port. Pranav Gupta, George Sidarous, Anup Tiwari, Nishant Vats, and Luke Warnock provided excellent

research assistance.

PRACHI MISHRA is a Deputy Division Chief and Mission Chief, Western Hemisphere Department,

International Monetary Fund (E-mail: pmishra0513@gmail.com). ARIELL RESHEF is Directeur de

Recherche du CNRS, Paris School of Economics, Universit´

e Paris 1 Panth´

eon-Sorbonne, and CEPII

(E-mail: ariell.reshef@psemail.eu).

Received June 21, 2017; and accepted in revised form June 18, 2018.

Journal of Money, Credit and Banking, Vol. 51, Nos. 2–3 (March–April 2019)

C

2018 The Ohio State University

370 :MONEY,CREDIT AND BANKING

However,the role of heads of central banks extends well beyond controlling inflation,

and covers financial regulation.

In this paper, we ask whether personal characteristics of central bank governors

are associated with financial regulation. In light of the special role that financial

regulation played in the recent financial crises in the United States and Europe,

it is important to understand the forces that shape it.1The leading role of central

bank governors in shaping policy in the aftermath of the crisis underscores the

importance of identifying factors that influence their behavior.And public perceptions

that central bank governors’ behavior has benefited the financial sector also merits

paying attention to what affects their actions.2

In order to address these questions, we construct a new data set with detailed

information on governors of central banks over the period 1970–2011. We find that,

even after controlling for political orientation of government, the professional back-

grounds of central bank governors have explanatory power for changes in financial

regulation. In particular, experience in the private financial sector is associated with

greater financial deregulation. Experience in international organizations matters too:

While experience in the International Monetary Fund (IMF) is similarly associated

with financial deregulation as experience in finance, governors’ experience at the

United Nations and at the Bank of International Settlements (BIS) is associated with

less deregulation.

Lacking a natural experiment, we cannot assert causality. However, the results are

consistent with the idea that central bank governors have a degree of control over

regulatory outcomes, and that their backgrounds can affect in which direction they

exert this control. This can be taken into account when choosing governors, as Romer

and Romer (2004) suggest.

Many central banks are statutorily in charge of financial regulation. In 2012, two-

thirds of central banks in a sample of 145 countries regulate their banking system,

while almost one-fourth regulate securities and insurance markets (Horakova 2012).3

In these cases, central banks not only determine the implementation of regulation, but

also influence the legal and regulatory environment.4Padoa-Schioppa (2003) argues

that until recently bank and financial supervision constituted an inseparable part of

central bank policy and actions.5

1. On the role of financial regulation, see, for example, Igan, Mishra, and Tressel (2012), Philippon

and Reshef (2012), and Boustanifar,Grant, and Reshef (2018). The Economist, May 1, 2015: What’s wrong

with finance? also explains how deregulation helped create the preconditions for the financial crisis.

2. For examples of these perceptions, see Adolph (2013), Sherman (2009), and The New YorkTimes,

October 8, 2008: Taking HardNew Look at a Greenspan Legacy.

3. In all cases where the central bank regulates its securities and/or insurance markets, it also regulates

the banking system.

4. Hirtle, Kovner, and Plosser (2016), demonstrate that discretion over bank supervision lead to

apparently less risky behavior in largebanks, without adversely affecting their competitiveness, supporting

the notion that supervision has a distinct role as a complement to regulation.

5. Padoa-Schioppa (2003) argues that in order to achieveboth financial stability andmonetary policy,

central banks applied bank supervision. Goodfriend and King (1988) argue that central banks must engage

in financial regulation in order to achieve monetary policy goals. More recently, Hellwig (2014) also

advocates the importance of bank and financial supervision for achieving the goals of central banks.

PRACHI MISHRA AND ARIELL RESHEF :371

Even in cases where financial regulation is not the direct responsibility of the cen-

tral bank, the governor may have great power to shape it, through public speeches,

special reports on the topic, and less-visible political connections. For example, as

chairman of the Federal Reserve, Alan Greenspan was extremely influential in advo-

cating financial deregulation in the United States and justifying it ((Sherman 2009,

Hacker and Pierson 2010, Johnson and Kwak 2010).6Bernanke was instrumental in

developing responses to the 2008 financial crisis in the United States, including new

financial regulation.7In France, concerns about potential conflicts of interest were

voiced in media and in the National Assembly about the appointment of Franc¸ois

Villeroy de Galhau as president of the Banque de France in 2015, in light of his

past experience as director general of BNP Paribas—in particular with respect to

bank supervision and regulation.8In this paper, we find that the relationship between

experience in finance and financial deregulation is indeed systematic.

The importance of central bank governors is manifested in many instances. For

example, in relation to the European debt crisis, Mario Draghi has come into the

limelight as the new head of the European Central Bank and as a break with previous

policies under Jean Claude Trichet.9Currently, Draghi is instrumental in shaping

monetary policy at the European Central Bank, reforming banking regulation, and

in coordinating policy more generally across the European Union. Responses to the

Asian crisis in 1997 differed across the directly affected countries—in particular,

imposing capital controls—and were influenced by central bank governors in the

countries that were directly involved. Stanley Fischer’s conduct as governor of the

Bank of Israel had a significant effect on how that country’s competitiveness and fi-

nancial stability was perceived, with arguably positive outcomes.10 The appointment

of Raghuram Rajan as the head of the Reserve Bank of India in September 2013 is

associated with calming financial markets, which were faced with bouts of volatil-

ity following the U.S. Federal Reserve announcements of tapering of purchases of

6. See also The Economist, May 1, 2015: What’s wrong with finance? Both Fed governors Paul

Volckerand Alan Greenspan are classified in our data set as having experience in “other private sector,”

as well as in the “financial sector.” Volcker’s first job was at the FRB of New York, and he also worked

for the treasury. In between he worked at Chase Manhattan Bank (in two separate job spells), rising to

the rank of Vice President, before becoming the Chairman of the Federal Reserve. Greenspan’s only job

in finance was his first, during graduate school. After this he worked mostly at his own consulting firm,

Townsend-Greenspan& Co., Inc., before becoming the Chairman of the Federal Reserve.

7. For example, in testimony to the U.S. Congress in November and December 2009, and in a speech

on January 3, 2010, Bernanke blamed regulatory failure for the financial crisis (not low interest rates), and

advocated outright banning of some financial products. These were part of the statements that prepared

the ground for the Dodd–Frank Act, which was signed into law on July 21, 2010. Bernanke had no work

experience in the financial sector when he was appointed.

8. Le Monde, 15 September 2015: Banque de France : Franc¸ois Villeroy de Galhau est expos´

e`

a

un grave conflit d’int´

erˆ

ets ,andBanque de France: la nomination d’un ex-dirigeant de BNP d´

enonc´

ee

par 150 ´

economistes (in French). Observatoire des Multinationales, Octobre 5, 2015: Quand le lobby

bancaire met la main sur la haute administration (in French).

9. For example, Financial Times,November 2, 2011: Mario Draghi’s historic choice.TheNew York

Time s, November 3, 2011: European Central Bank, Under New Chief, Cuts Key Rate and The NewYork

Time s, November 3, 2011: Mr. DraghiMakes a Start.

10. The International Institute for Management Development, WorldCompetitiveness Yearbook 2010.

Fischer received an Arating on Global Finance’s Central BankerReport Card in 2009, 2010, and 2011.