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Time Inconsistency and Free-Riding in a Monetary Union

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  • VARADARAJAN V. CHARI
  • PATRICK J. KEHOE

Abstract

In monetary unions, a time inconsistency problem in monetary policy leads to a novel type of free-rider problem in the setting of non-monetary policies. The free-rider problem leads union members to pursue lax non-monetary policies that induce the monetary authority to generate high inflation. Free-riding can be mitigated by imposing constraints on non-monetary policies. Without a time inconsistency problem, the union has no free-rider problem; then constraints on non-monetary policies are unnecessary and possibly harmful. This theory is here detailed and applied to several non-monetary policies: labor market policy, fiscal policy, and bank regulation. Copyright (c) 2008 Federal Reserve Bank of Minneapolis with Exclusive License to Print by The Ohio State University.

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Bibliographic Info

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

Volume (Year): 40 (2008)
Issue (Month): 7 (October)
Pages: 1329-1356

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Handle: RePEc:mcb:jmoncb:v:40:y:2008:i:7:p:1329-1356

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

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