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Optimal commitment in an open economy: Credibility vs. flexibility

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Author Info

  • Eijffinger, S.C.W.
  • Schaling, E.

    (Tilburg University, Center for Economic Research)

Abstract

Using a graphical method, a new way of determining the optimal degree of central bank conservativeness is developed in this paper. Unlike Lohmann (1992) and Rogoff (1985a), we are able to express the upper and lower bounds of the interval containing the optimal degree of conservativeness in terms of the structural parameters of the model. Next, we show that optimal central bank independence is higher, the higher the natural rate of unemployment, the greater the benefits of unanticipated inflation, the less inflation-averse society, the smaller the variance of productivity shocks, the smaller real exchange rate variability and the smaller the openness of the economy. These propositions are tested for nineteen industrial countries (Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, New Zealand, the Netherlands, Norway, Spain, Sweden, Switzerland, the United Kingdom and the United States) for the Bretton-Woods period and after (1960-1993). In testing the model we employ a latent variables method (LISREL) in order to distinguish between actual and optimal monetary regimes.

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Bibliographic Info

Paper provided by Tilburg University, Center for Economic Research in its series Discussion Paper with number 1995-79.

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Date of creation: 1995
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Handle: RePEc:dgr:kubcen:199579

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Web page: http://center.uvt.nl

Related research

Keywords: Central Banks; Credibility; Independence; monetary economics;

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References

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  1. Eijffinger, S.C.W. & Schaling, E., 1993. "Central bank independence: Theory and evidence (Revised version)," Discussion Paper 1993-25, Tilburg University, Center for Economic Research.
  2. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
  3. David Romer, 1991. "Openness and inflation: theory and evidence," Proceedings, Federal Reserve Bank of San Francisco, issue Nov.
  4. Eijffinger, S. & De Hann, J., 1995. "The Political Economy of Central Bank Independence," Papers 9587, Tilburg - Center for Economic Research.
  5. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  6. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  7. Fischer, Stanley, 1977. "Wage indexation and macroeconomics stability," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 5(1), pages 107-147, January.
  8. Taylor, John B., 1983. "`Rules, discretion and reputation in a model of monetary policy' by Robert J. Barro and David B. Gordon," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 123-125.
  9. Eijffinger, S. & van Keulen, M., 1994. "Central Bank Independence in Another Eleven Countries," Papers 9494, Tilburg - Center for Economic Research.
  10. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  11. Eijffinger, S.C.W., 1993. "Central bank independence in twelve industrial countries," Open Access publications from Tilburg University urn:nbn:nl:ui:12-152908, Tilburg University.
  12. Persson, Torsten & Tabellini, Guido, 1993. "Designing institutions for monetary stability," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 53-84, December.
  13. Eijffinger, S.C.W. & Schaling, E., 1992. "Central bank independence: Criteria and indices," Research Memorandum 548, Tilburg University, Faculty of Economics and Business Administration.
  14. Alberto Alesina, 1988. "Macroeconomics and Politics," NBER Chapters, in: NBER Macroeconomics Annual 1988, Volume 3, pages 13-62 National Bureau of Economic Research, Inc.
  15. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
  16. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  17. Carl E Walsh, 1993. "Optimal contracts for independent central bankers: private information, performance measures and reappointment," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  18. Manfred Neumann, 1991. "Precommitment by central bank independence," Open Economies Review, Springer, vol. 2(2), pages 95-112, June.
  19. Alesina, Alberto & Summers, Lawrence H, 1993. "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 151-62, May.
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Citations

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Cited by:
  1. Alexander Mihailov, 2007. "Does Instrument Independence Matter under the Constrained Discretionof an Inflation Targeting Goal? Lessons from UK Taylor Rule Empirics," Money Macro and Finance (MMF) Research Group Conference 2006 95, Money Macro and Finance Research Group.
  2. Eijffinger, S.C.W. & Hoeberichts, M.M., 1998. "The trade off between central bank independence and conservativeness," Open Access publications from Tilburg University urn:nbn:nl:ui:12-76576, Tilburg University.
  3. Marcello D'Amato & Riccardo Martina, 2000. "Credibility and Commitment of Monetary Policy in Open Economies," CSEF Working Papers 47, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.

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