Abstract:
1. Introduction
Previous studies on Central Bank independence (CBI) were directed to
several aspects such as developing CBI measurements, developing theories
for the CBI, effects of CBI on macro-economic variables, etc. With the
presence of political business cycles (PBC) and poor good governance (GG)
in Sri Lanka, this study argues that it would result in a lack of policy
convergence. Therefore, it hypothesizes that if poor governance leads to a
decrease in policy convergence, and if low levels of policy convergence
further reduce CBI, then policy convergence will play a significant
mediating role in the relationship between governance and CBI. Thus, the
study aims to investigate the mediation effect in the relationship between
GG and CBI.
2. Research Methodology
A quantitative analysis is performed to derive the results through
secondary data under convenience sampling. The study concerns inflation
at one integer, GG indicators, exchange rates, and interest rates as variables
in the study. A three-stage least square model is used over the sample
period from 1996 to 2023 to test the hypothesis. Meantime, the level of
policy convergence is tested by using a vector error correction model.
3. Findings and Discussion
The results indicate that monetary and fiscal policy convergence is
achieved in the short run, and therefore, the above hypothesis is partially
accepted. That is, even though the prevailing governance factors
significantly affected the policy convergence in the country, policy
convergence, in turn, has not significantly influenced the CBI. However. The
direct effect of GG on CBI is statistically significant.
4. Conclusions and Implications
Thus, this study emphasizes the importance of strengthening governance
factors in the country. Further, by prioritizing improvements in
governance, policymakers can increase CBI, which, in turn, is likely to lead
to a more effective monetary system
