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Delegation of Monetary Policy: More than a Relocation of the Time-Inconsistency Problem

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  • Driffill, John
  • Rotondi, Zeno

Abstract

It has been argued that delegation of monetary policy to an independent central bank, which acts as an agent for the government, does not mitigate the problem of time-inconsistency, but merely relocates it. We argue here that this is not so, and that delegation enables a wider class of economies to sustain zero inflation than would be able to do so in its absence. We consider an economy in which the government faces re-appointment costs, that is, costs associated with sacking one central banker and replacing them with another, costs which are intended to protect central bank independence. We show that, by means of suitable announcements of incentive schemes for the central bank, combined with appropriate actually implemented schemes, delegated policy enables zero inflation to prevail in economies in which it could not do so without delegated policy. These economies are ones that have relatively high discount rates (and so low discount factors).

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3923.

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Date of creation: Jun 2003
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Handle: RePEc:cpr:ceprdp:3923

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Keywords: credibility; delegation; independent central banks; monetary policy; time-inconsistency;

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References

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  1. Robert J. Barro & David B. Gordon, 1983. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
  2. McCallum, Bennett T., 1997. "Crucial issues concerning central bank independence," Journal of Monetary Economics, Elsevier, Elsevier, vol. 39(1), pages 99-112, June.
  3. McCallum, Bennett T, 1995. "Two Fallacies Concerning Central-Bank Independence," American Economic Review, American Economic Association, vol. 85(2), pages 207-11, May.
  4. Persson, Torsten & Tabellini, Guido, 1997. "Political Economics and Macroeconomic Policy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1759, C.E.P.R. Discussion Papers.
  5. Herrendorf, Berthold, 1998. "Inflation Targeting as a Way of Precommitment," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 431-48, July.
  6. D. Backus & J. Driffil, 1998. "Inflation and Reputation," Levine's Working Paper Archive 625, David K. Levine.
  7. Adam S. Posen, 1995. "Declarations Are Not Enough: Financial Sector Sources of Central Bank Independence," NBER Chapters, in: NBER Macroeconomics Annual 1995, Volume 10, pages 253-274 National Bureau of Economic Research, Inc.
  8. Jensen, Henrik, 1997. "Credibility of Optimal Monetary Delegation," American Economic Review, American Economic Association, vol. 87(5), pages 911-20, December.
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Cited by:
  1. Ullrich, Katrin, 2003. "Unabhängigkeit und Verantwortlichkeit der Europäischen Zentralbank," ZEW Discussion Papers 03-65, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.

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