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The Political Economy of Inflation and Central Bank Independence

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  • Herrendorf, Berthold
  • Neumann, Manfred J.M.

Abstract

We study monetary policy-making in an economy with many sector-specific monopoly unions. It is assumed that the senior union members are in the majority and – due to the practice of lay-offs by inverse seniority – face a lower unemployment risk than the junior members. Consequently, the unions’ median voters are senior and set nominal wages that imply involuntary unemployment on part of the juniors. Thus, equilibrium unemployment is too high from a social welfare point of view. Nevertheless, an independent central bank is found not to produce an inflation bias because it is accountable to the majority of the population, which is not involuntarily unemployed. In contrast, government-dependence leads to an inflation bias and a higher variability of inflation, but has an ambiguous effect on employment variability. The reason is that democratic elections are about more than one policy issue, which is shown to give rise to political uncertainty about the monetary policy preferences of the elected government.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1787.

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Date of creation: Jan 1998
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Handle: RePEc:cpr:ceprdp:1787

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Related research

Keywords: Central Bank Independence; Inflation Bias; Median Voter; political uncertainty;

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Cited by:
  1. Debora Di Gioacchino & Sergio Ginebri & Laura Sabani, 2004. "Political support for anti-inflationary monetary policy," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 9(2), pages 187-200.
  2. Gustavo Piga, 2005. "On the Sources of the Inflation Bias and Output Variability," CEIS Research Paper 66, Tor Vergata University, CEIS.
  3. Castrén, Olli, 1998. "Monetary Policy Delegation, Labour Market Structure and Fiscal-Monetary Policy Coordination," Research Discussion Papers 14/1998, Bank of Finland.
  4. Herrendorf, Berthold & Neumann, Manfred J.M., 1998. "The Political Economy of Inflation, Labour Market Distortions and Central Bank Independence," CEPR Discussion Papers 1969, C.E.P.R. Discussion Papers.

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