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Caution and conservatism in the making of monetary policy

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  • Schellekens, Philip
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    Abstract

    Does society benefit from the delegation of monetary policy to cautious and conservative central bankers? We offer a critical view on the delegation literature and relax seemingly innocuous assumptions about uncertainty and preferences. First, caution improves credibility but does not obviate the need for central-bank conservatism. Second, previous models of delegation have focused on suboptimal forms of conservatism. We derive optimal concepts of conservatism that mitigate, or eliminate, any residual problem of credibility. Third, we rationalize why credible monetary policy may be conducive to stable inflation and output. JEL Classification: E50

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    Paper provided by European Central Bank in its series Working Paper Series with number 0025.

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    Date of creation: Jul 2000
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    Handle: RePEc:ecb:ecbwps:20000025

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    1. Waller, Christopher J & Walsh, Carl E, 1996. "Central-Bank Independence, Economic Behavior, and Optimal Term Lengths," American Economic Review, American Economic Association, vol. 86(5), pages 1139-53, December.
    2. McCallum, Bennett T, 1995. "Two Fallacies Concerning Central-Bank Independence," American Economic Review, American Economic Association, vol. 85(2), pages 207-11, May.
    3. Pearce, Douglas K. & Sobue, Motoshi, 1997. "Uncertainty and the inflation bias of monetary policy," Economics Letters, Elsevier, vol. 57(2), pages 203-207, December.
    4. Jensen, Henrik, 1997. "Credibility of Optimal Monetary Delegation," American Economic Review, American Economic Association, vol. 87(5), pages 911-20, December.
    5. 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.
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    7. Maurice Obstfeld, 1991. "Destabilizing Effects of Exchange-Rate Escape Clauses," NBER Working Papers 3603, National Bureau of Economic Research, Inc.
    8. Craine, Roger, 1979. "Optimal monetary policy with uncertainty," Journal of Economic Dynamics and Control, Elsevier, vol. 1(1), pages 59-83, February.
    9. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," NBER Working Papers 5893, National Bureau of Economic Research, Inc.
    10. King, Mervyn, 1997. "Changes in UK monetary policy: Rules and discretion in practice," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 81-97, June.
    11. Laurence Ball & Stephen G. Cecchetti, 1990. "Inflation and Uncertainty at Long and Short Horizons," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1), pages 215-254.
    12. William Poole, 1969. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Special Studies Papers 2, Board of Governors of the Federal Reserve System (U.S.).
    13. Swank, Otto H, 1994. " Better Monetary Control May Increase the Inflationary Bias of Policy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 96(1), pages 125-31.
    14. Letterie, Wilko, 1997. " Better Monetary Control May Decrease the Distortion of Stabilisation Policy: A Comment," Scandinavian Journal of Economics, Wiley Blackwell, vol. 99(3), pages 463-70, September.
    15. 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.
    16. 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.
    17. Devereux, Michael, 1987. "The effect of monetary variability on welfare in a simple macroeconomic model," Journal of Monetary Economics, Elsevier, vol. 19(3), pages 427-435, May.
    18. Matthew B. Canzoneri, 1983. "Monetary policy games and the role of private information," International Finance Discussion Papers 249, Board of Governors of the Federal Reserve System (U.S.).
    19. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, December.
    20. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    21. Caplin, Andrew & Leahy, John, 1996. "Monetary Policy as a Process of Search," American Economic Review, American Economic Association, vol. 86(4), pages 689-702, September.
    22. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
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