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Explicit inflation targets and central bank independence: friends or foes?

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  • Andrew Hallett

    ()

  • Jan Libich

    ()

Abstract

The paper studies the relationship between two institutional innovations in monetary policy of the past few decades: central bank independence (CBI) and explicit inflation targeting (EIT). The aim is to make inferences about the optimal institutional design of monetary policy, and the right sequencing of policy reform. Our reduced-form model unifies several approaches in the literature, and offers three novel institutional findings (that we square with existing empirical evidence). First, instrument-CBI is a complement to EIT, whereas goal-CBI acts as a strategic substitute for EIT in ensuring low inflation and policy credibility. Second, out of these two ‘commitment technologies,’ EIT is shown to be socially superior to goal-CBI. Third and controversially, countries that first implement goal-CBI are then less likely to adopt the desirable EIT regime. This is because independent central bankers may have less need to do so (their independence partly substitutes for EIT), as well as less willingness to do so (due to a higher degree of accountability associated with a transparently legislated target). Our analysis therefore implies that developing and emerging market countries should go down the New Zealand route—legislate EIT together with instrument-CBI, but stay clear of goal-CBI. Unfortunately, many transition countries have followed the opposite Fed/Bundesbank route, which we show may have adverse welfare consequences through several channels. Copyright Springer Science+Business Media, LLC. 2012

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Bibliographic Info

Article provided by Springer in its journal Economic Change and Restructuring.

Volume (Year): 45 (2012)
Issue (Month): 4 (November)
Pages: 271-297

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Handle: RePEc:kap:ecopln:v:45:y:2012:i:4:p:271-297

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Web page: http://www.springerlink.com/link.asp?id=113294

Related research

Keywords: Institutional reform; Transition economies; Explicit inflation targeting; Central bank independence; Transparency; Accountability; Credibility; Monitoring; Reputation; E52; E61; C72;

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References

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Citations

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Cited by:
  1. Meixing Dai & Moïse Sidiropoulos, 2010. "Monetary and fiscal policy interactions with central bank transparency and public investment," Working Papers of BETA 2010-21, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
  2. Meixing Dai & Eleftherios Spyromitros, 2009. "Accountability and Transparency about Central Bank Preferences for Model Robustness," Working Papers of BETA 2009-18, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
  3. Hughes Hallett, Andrew & Libich, Jan & Stehlík, Petr, 2007. "Monetary and Fiscal Policy Interaction with Various Degrees and Types of Commitment," CEPR Discussion Papers 6586, C.E.P.R. Discussion Papers.
  4. Andrew Hughes Hallet & Jan Libich & Petr Stehlik, 2008. "Welfare Improving Coordination Of Fiscal And Monetary Policy," CAMA Working Papers 2008-04, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.

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