Since the 1980s many countries have reformed the institutional framework governing their central banks to increase operational independence. Collecting systematic biographical information, international press coverage, and independent expert opinions, we find that over the same period appointments of central bank governors have become more politically motivated, especially after significant legislative reforms aiming to insulate central banks and their governors from political interference. We also show that politically-motivated appointments reflect lower de facto independence, and are associated with worse inflation and financial stability outcomes. Given the increase in central banks' powers worldwide, our findings inform the debate about their political accountability and credibility.

When the Federal Reserve (Fed) expanded its balance sheet via quantitative easing (QE), commercial banks financed reserve holdings with deposits and reduced their average maturity. They also issued lines of credit to corporations. However, when the Fed halted its balance-sheet expansion in 2014 and even reversed it during quantitative tightening (QT) starting in 2017, there was no commensurate shrinkage of these claims on liquidity. Consequently, the past expansion of the Fed’s balance sheet appears to have left the financial sector more sensitive to potential liquidity shocks when the Fed started shrinking its balance sheet, necessitating Fed liquidity provision in September 2019 and again in March 2020. The banks most exposed to liquidity claims suffered the most drawdowns and the largest stock price declines in March 2020. This evidence suggests that the shrinkage of central bank balance sheets must be handled with utmost care as it may involve tradeoffs between monetary policy and financial stability.

Exploiting the introduction of the ECB’s tiering system for remunerating excess reserve holdings, we document the importance of money market access for bank lending. We show that the two-tier system produced positive wealth effects for banks with excess reserves and encouraged banks with unused exemptions to increase their participation in the money market to obtain liquidity. This ultimately decreased money market fragmentation and enhanced the transmission of monetary policy. We provide evidence that stronger money market relationships reduce the precautionary behavior of financially constrained banks with unused allowances, which consequently extend more credit than other banks, including those with excess liquidity whose valuations increased the most.