Economic Policy Uncertainty and Institutional Credibility: Assessing the Role of Central Bank Independence in Maintaining Financial Stability in (D-8) Countries

Abstract

This study examines the impact of economic policy uncertainty (EPU) and central bank independence (CBI) on financial stability in the Developing Eight (D-8) Muslim countries, which are often identified as emerging markets and are vulnerable to geopolitical risks. Challenging the prevailing view of central bank independence (CBI), we find new evidence that its effectiveness depends heavily on institutional quality. Using a dynamic panel estimator based on the Generalized Method of Moments (GMM) over the 2009–2022 study period, we also introduce a new three-layer control structure that accounts for internal, external, and institutional factors. Our results demonstrate a nonlinear U-shaped relationship between EPU and financial stability, where extreme uncertainty paradoxically triggers defensive financial mechanisms. Furthermore, we uncover the institutional credibility paradox, where CBI exhibits an adverse average effect, often exacerbating financial instability in institutionally weak environments. The moderating role of CBI on EPU also appears counterproductive, indicating that independence without institutional foundations amplifies shocks from policy uncertainty. This study contributes to the political economy literature by demonstrating that institutional credibility is not simply a matter of legal autonomy but rather a fundamental prerequisite for effective monetary governance. We argue that the conventional CBI model requires significant re-evaluation in emerging markets, where institutional complementarity is more crucial to financial resilience than central bank independence alone.