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Fiscal Policy and the Implementation of the Walsh Contract for Central Bankers

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  • Haizhou Huang

    ()
    (International Monetary Fund)

  • A. Jorge Padilla

    ()
    (CEMFI)

Abstract

We develop a simple macroeconomic model where the time inconsistency of optimal monetary policy is due to tax distortions. If fiscal policy is exogenously fixed at its optimal level, a Walsh contract (Walsh, 1995) offered to an independent central bank implements the optimal monetary policy. When fiscal policy is determined endogenously, however, this contract is subject to strategic manipulation by the government, which results in a suboptimal policy mix. Implementing the optimal policy mix requires either that the central bank enjoy primacy over the fiscal authority or that fiscal policy be also delegated to an independent authority.

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Bibliographic Info

Article provided by Society for AEF in its journal Annals of Economics and Finance.

Volume (Year): 3 (2002)
Issue (Month): 1 (May)
Pages: 27-42

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Handle: RePEc:cuf:journl:y:2002:v:3:i:1:p:27-42

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Related research

Keywords: Central banking; Optimal contracts; Monetary and fiscal policy; Strategic manipulation; Nash implementation;

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References

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  1. Taylor, John B., 1983. "`Rules, discretion and reputation in a model of monetary policy' by Robert J. Barro and David B. Gordon," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 123-125.
  2. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  3. Guy Debelle & Stanley Fischer, 1994. "How independent should a central bank be?," Working Papers in Applied Economic Theory 94-05, Federal Reserve Bank of San Francisco.
  4. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
  5. Backus, David & Driffill, John, 1985. "Inflation and Reputation," American Economic Review, American Economic Association, vol. 75(3), pages 530-38, June.
  6. Guy Debelle, 1996. "Central Bank Independence," IMF Working Papers 96/1, International Monetary Fund.
  7. Calvo, Guillermo A, 1978. "On the Time Consistency of Optimal Policy in a Monetary Economy," Econometrica, Econometric Society, vol. 46(6), pages 1411-28, November.
  8. Canzoneri, Matthew B, 1985. "Monetary Policy Games and the Role of Private Information," American Economic Review, American Economic Association, vol. 75(5), pages 1056-70, December.
  9. Charles Goodhart, 1993. "Central Bank Independence," FMG Special Papers sp57, Financial Markets Group.
  10. Alesina, Alberto & Tabellini, Guido, 1987. "Rules and Discretion with Noncoordinated Monetary and Fiscal Policies," Economic Inquiry, Western Economic Association International, vol. 25(4), pages 619-30, October.
  11. Bulow, Jeremy I & Geanakoplos, John D & Klemperer, Paul D, 1985. "Multimarket Oligopoly: Strategic Substitutes and Complements," Journal of Political Economy, University of Chicago Press, vol. 93(3), pages 488-511, June.
  12. Canzoneri, Matthew B & Nolan, Charles & Yates, Anthony, 1997. "Mechanisms for Achieving Monetary Stability: Inflation Targeting versus the ERM," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(1), pages 46-60, February.
  13. Robert J. Barro, 1986. "Reputation in a Model of Monetary Policy with Incomplete Information," NBER Working Papers 1794, National Bureau of Economic Research, Inc.
  14. Fratianni, Michele & von Hagen, Jurgen & Waller, Christopher J, 1997. "Central Banking as a Political Principal-Agent Problem," Economic Inquiry, Western Economic Association International, vol. 35(2), pages 378-93, April.
  15. Kent Osband & Delano Villanueva, 1992. "Independent Currency Authorities," IMF Working Papers 92/50, International Monetary Fund.
  16. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  17. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  18. William D. Nordhaus, 1994. "Policy games: Coordination and Independece in Monetary and Fiscal Policies," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(2), pages 139-216.
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Citations

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Cited by:
  1. Haizhou Huang & Shang-Jin Wei, 2003. "Monetary Policies for Developing Countries," IMF Working Papers 03/183, International Monetary Fund.
  2. Huang, Haizhou & Wei, Shang-Jin, 2005. "Monetary Policies for Developing Countries: The Role of Institutional Quality," CEPR Discussion Papers 4911, C.E.P.R. Discussion Papers.
  3. Haizhou Huang & Shang-Jin Wei, 2003. "Monetary Policies for Developing Countries: The Role of Corruption," NBER Working Papers 10093, National Bureau of Economic Research, Inc.

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