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Inflation Targets and Contracts with Uncertain Central Banker Preferences

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  • Beetsma, Roel M W J
  • Jensen, Henrik

Abstract

Within a standard model of monetary delegation the authors show that the optimal linear inflation contract performs strictly better than the optimal inflation target when there is uncertainty about the central banker's preferences. The optimal combination of a contract and a target performs best and eliminates the inflation bias and any variability not associated with supply shocks. However, variability due to shocks is enhanced by uncertain central banker preferences. Quadratic contracts are shown to overcome this problem partly, but the advantages of delegation may still be dominated by the 'excess variability' due to shocks. Hence, the credibility-stabilization tradeoff is restored.

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Bibliographic Info

Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 30 (1998)
Issue (Month): 3 (August)
Pages: 384-403

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Handle: RePEc:mcb:jmoncb:v:30:y:1998:i:3:p:384-403

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. D. Backus & J. Driffil, 1998. "Inflation and Reputation," Levine's Working Paper Archive 625, David K. Levine.
  2. Herrendorf, Berthold & Lockwood, Ben, 1996. "Rogoff's Conservative Central Banker Restored," The Warwick Economics Research Paper Series (TWERPS) 450, University of Warwick, Department of Economics.
  3. Stanley Fischer, 1995. "Modern Approaches to Central Banking," NBER Working Papers 5064, National Bureau of Economic Research, Inc.
  4. Alesina, Alberto & Gatti, Roberta, 1995. "Independent Central Banks: Low Inflation at No Cost?," American Economic Review, American Economic Association, vol. 85(2), pages 196-200, May.
  5. Charles Nolan & Eric Schaling, 1996. "Monetary Policy Uncertainty and Central Bank Accountability," Bank of England working papers 54, Bank of England.
  6. 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.
  7. 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.
  8. Lossani, Marco & Natale, Piergiovanna & Tirelli, Patrizio, 1998. "Incomplete Information in Monetary Policy Games: Rules Rather Than a Conservative Central Banker," Scottish Journal of Political Economy, Scottish Economic Society, vol. 45(1), pages 33-47, February.
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