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The politics of central bank independence: a theory of pandering and learning in government

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  • Gauti Eggertsson
  • Eric Le Borgne

Abstract

We propose a theory to explain why, and under what circumstances, a politician endogenously gives up rent and delegates policy tasks to an independent agency. Applied to monetary policy, this theory (i) formalizes the rationale for delegation highlighted by Alexander Hamilton, the first Secretary of the Treasury of the United States, and by Alan S. Blinder, former Vice Chairman of the Board of Governors of the Federal Reserve System; and (ii) does not rely on the inflation bias that underlies most existing theories of central bank independence. Delegation trades off the cost of having a possibly incompetent technocrat with a long-term job contract against the benefit of having a technocrat who (i) invests more effort into the specialized policy task and (ii) has less incentive to pander to public opinion than a politician. Our key theoretical predictions are broadly consistent with the data.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 205.

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Date of creation: 2005
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Handle: RePEc:fip:fednsr:205

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Keywords: Banks and banking; Central ; Monetary policy ; Political science;

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References

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  1. Eric Maskin & Jean Tirole, 2004. "The Politician and the Judge: Accountability in Government," American Economic Review, American Economic Association, vol. 94(4), pages 1034-1054, September.
  2. Clarida, R. & Gali, J. & Gertler, M., 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Working Papers 99-13, C.V. Starr Center for Applied Economics, New York University.
  3. Xiang Lin, 1999. "Central-Bank Independence, Economic Behavior, and Optimal Term Lengths: Comment," American Economic Review, American Economic Association, vol. 89(4), pages 1056-1062, September.
  4. Ben Lockwood & Eric Le Borgne, 2003. "Do Elections Always Motivate Incumbents? Experimentation vs. Career Concerns," IMF Working Papers 03/57, International Monetary Fund.
  5. Stephen Coate & Timothy Besley, 2000. "Elected versus Appointed Regulators: Theory and Evidence," NBER Working Papers 7579, National Bureau of Economic Research, Inc.
  6. Edward P. Lazear & Sherwin Rosen, 1979. "Rank-Order Tournaments as Optimum Labor Contracts," NBER Working Papers 0401, National Bureau of Economic Research, Inc.
  7. Alberto Alesina & Guido Tabellini, 2003. "Bureaucrats or Politicians?," Harvard Institute of Economic Research Working Papers 2009, Harvard - Institute of Economic Research.
  8. McCallum, Bennett T, 1995. "Two Fallacies Concerning Central-Bank Independence," American Economic Review, American Economic Association, vol. 85(2), pages 207-11, May.
  9. Svensson, Lars E O, 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," CEPR Discussion Papers 1249, C.E.P.R. Discussion Papers.
  10. Torsten Persson & Guido Tabellini, 1997. "Political Economics and Macroeconomic Policy," NBER Working Papers 6329, National Bureau of Economic Research, Inc.
  11. Guy Debelle & Stanley Fischer, 1994. "How independent should a central bank be?," Working Papers in Applied Economic Theory 94-05, Federal Reserve Bank of San Francisco.
  12. Fischer, Stanley, 1995. "Central-Bank Independence Revisited," American Economic Review, American Economic Association, vol. 85(2), pages 201-06, May.
  13. Muscatelli, Anton, 1998. "Optimal Inflation Contracts and Inflation Targets with Uncertain Central Bank Preferences: Accountability through Independence?," Economic Journal, Royal Economic Society, vol. 108(447), pages 529-42, March.
  14. 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.
  15. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608.
  16. 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.
  17. Alesina, Alberto & Gatti, Roberta, 1995. "Independent Central Banks: Low Inflation at No Cost?," American Economic Review, American Economic Association, vol. 85(2), pages 196-200, May.
  18. Gauti B. Eggertsson, 2003. "How to Fight Deflation in a Liquidity Trap: Committing to Being Irresponsible," IMF Working Papers 03/64, International Monetary Fund.
  19. Gauti B. Eggertsson & Eric Le Borgne, 2010. "A Political Agency Theory of Central Bank Independence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(4), pages 647-677, 06.
  20. Haan, Jakob de & Kooi, Willem J., 2000. "Does central bank independence really matter?: New evidence for developing countries using a new indicator," Journal of Banking & Finance, Elsevier, vol. 24(4), pages 643-664, April.
  21. Lippi, Francesco, 1998. " On Central Bank Independence and the Stability of Policy Targets," Scandinavian Journal of Economics, Wiley Blackwell, vol. 100(2), pages 495-512, June.
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Citations

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Cited by:
  1. Leonardo Martinez, 2009. "Reputation, career concerns, and job assignments," Working Paper 06-01, Federal Reserve Bank of Richmond.
  2. Martinez, Leonardo, 2009. "A theory of political cycles," Journal of Economic Theory, Elsevier, vol. 144(3), pages 1166-1186, May.
  3. Peter Stella & Ulrich H. Klueh, 2008. "Central Bank Financial Strength and Policy Performance: An Econometric Evaluation," IMF Working Papers 08/176, International Monetary Fund.
  4. Andrew Foerster & Leonardo Martinez, 2006. "Are we working too hard or should we be working harder? A simple model of career concerns," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 79-91.

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