Endogenous selection of monetary institutions: With the case of discount windows and bureaucratic discretion

Abstract

Institutional or regulatory selection can often be endogenous in that the selection is made by state authorities mainly to serve their own interests. We apply this law-and-economics proposition to representative monetary institutions: "open market operation" versus "discount windows". Both instruments have been dominantly treated as "indifferent" either in traditional macroeconomic theory or in existing central banking laws. Nonetheless, we observe fairly differing degrees of the relative reliance on discount windows across 71 countries. This paper is the first-time attempt to empirically explain these country-specific differences by means of our multi-dimensional proxies of the bureaucratic discretionary power. It confirms that the monetary authority's discretionary power per se, rather than the conventional factors such as economic development or the central bank's independence, plays a far more important role in explaining the relative reliance on discount windows. (c) 2007 Elsevier Inc. All rights reserved.