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Independent but Accountable: Walsh Contracts and the Credibility Problem

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  • Al-Nowaihi, A
  • Levine, Paul L

Abstract

Walsh (1995) addresses the government-central bank principal-agent problem where there exists a severe information extraction problem. This is solved by a ‘Walsh contract’ which links the income of the central bank to observed macroeconomic variables, output and inflation. The contract does not solve the time-inconsistency problem, however. There will be circumstances where a renegotiation of the contract benefits all parties involved and non-renegotiation-proofness destroys its credibility as a commitment device. But the contract’s strength is that renegotiation can be very visible and this facilitates a reputational solution to the problem, set out in this paper.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1387.

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Date of creation: Apr 1996
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Handle: RePEc:cpr:ceprdp:1387

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Related research

Keywords: Central Bank Contract; Credibility; Renegotiation; Reputation;

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Cited by:
  1. Anton Muscatelli, 1996. "Political Consensus, Uncertain Preferences and Central Bank Independence," Working Papers 9615, Business School - Economics, University of Glasgow, revised Nov 1996.
  2. Francesca Castellani & Xavier Debrun, 2001. "Central Bank Independence and the Design of Fiscal Institutions," IMF Working Papers 01/205, International Monetary Fund.
  3. Herrendorf, Berthold, 1998. "Inflation Targeting as a Way of Precommitment," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 431-48, July.
  4. Rotondi, Zeno, 2000. "Designing instrument rules for monetary stability: the optimality of interest-rate smoothing," Discussion Paper Series In Economics And Econometrics 0008, Economics Division, School of Social Sciences, University of Southampton.
  5. M. Lossani & P. Natale, & P. Tirelli, 1997. "Fiscal Policy and Imperfectly Credible Inflation Targets: Should We Appoint Expenditure-Conservative Central Bankers?," Working Papers 9707, Business School - Economics, University of Glasgow.
  6. al-Nowaihi, Ali & Levine, Paul, 1998. "Can political monetary cycles be avoided?," Journal of Monetary Economics, Elsevier, vol. 42(3), pages 525-545, October.
  7. Rotondi, Zeno, 2000. "Credibility of optimal monetary delegation: do we really need prohibitive reappointment costs?," Discussion Paper Series In Economics And Econometrics 0003, Economics Division, School of Social Sciences, University of Southampton.
  8. Lossani, Marco & Natale, Piergiovanna & Tirelli, Patrizio, 2000. "Fiscal Policy and Inflation Targets: Does Credibility Matters?," MPRA Paper 18693, University Library of Munich, Germany.
  9. Ali al-Nowaihi & Dean Garratt, 1998. "The New Political Macroeconomics," Discussion Papers in Economics 98/05, Department of Economics, University of Leicester.

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