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A Political Agency Theory of Central Bank Independence

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  • Gauti B. Eggertsson
  • Eric Le Borgne

Abstract

We propose a theory to explain why, and under what circumstances, a politician gives up rent and delegates policy tasks to an independent agency. We apply this theory to monetary policy by extending a standard dynamic "New-Keynesian" stochastic general equilibrium model. This model gives a new theory of central bank independence that is unrelated to the standard inflation bias problem. We derive several new predictions and show that they are consistent with the data. Finally, we show that while instrument independence of the central bank is desirable, goal independence is not.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 03/144.

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Length: 44
Date of creation: 01 Jul 2003
Date of revision:
Handle: RePEc:imf:imfwpa:03/144

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Keywords: Central bank role; Economic models; inflation; monetary policy; central bank; average inflation; independent central bank; nominal interest rate; lower inflation; inflation target; monetary policy decision; stable prices; inflation rate; monetary fund; low inflation; monetary regimes; inflation-targeting; intermediate monetary target; monetary stability; independent monetary policy; monetary policy regimes; monetary theory; real interest rate; monetary target; monetary policy decisions; real rate of interest; inflation targeting;

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References

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  1. Svensson, Lars E O, 1997. "Optimal Inflation Targets, "Conservative" Central Banks, and Linear Inflation Contracts," American Economic Review, American Economic Association, American Economic Association, vol. 87(1), pages 98-114, March.
  2. Waller, Christopher J & Walsh, Carl E, 1996. "Central-Bank Independence, Economic Behavior, and Optimal Term Lengths," American Economic Review, American Economic Association, American Economic Association, vol. 86(5), pages 1139-53, December.
  3. Kenneth Rogoff, 1987. "Equilibrium Political Budget Cycles," NBER Working Papers 2428, National Bureau of Economic Research, Inc.
  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. Guy Debelle & Stanley Fischer, 1994. "How independent should a central bank be?," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, Federal Reserve Bank of Boston, vol. 38, pages 195-225.
  6. Muscatelli, Anton, 1998. "Optimal Inflation Contracts and Inflation Targets with Uncertain Central Bank Preferences: Accountability through Independence?," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 108(447), pages 529-42, March.
  7. Godfrey Keller & Sven Rady, 1998. "Optimal Experimentation in a Changing Environment," Game Theory and Information, EconWPA 9801001, EconWPA.
  8. Schellekens, Philip, 2002. "Caution and Conservatism in the Making of Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 34(1), pages 160-77, February.
  9. Lazear, Edward P & Rosen, Sherwin, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 89(5), pages 841-64, October.
  10. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2139, C.E.P.R. Discussion Papers.
  11. Alesina, Alberto & Gatti, Roberta, 1995. "Independent Central Banks: Low Inflation at No Cost?," American Economic Review, American Economic Association, American Economic Association, vol. 85(2), pages 196-200, May.
  12. John Ferejohn, 1986. "Incumbent performance and electoral control," Public Choice, Springer, Springer, vol. 50(1), pages 5-25, January.
  13. Lockwood, Ben, 1997. "State-Contingent Inflation Contracts and Unemployment Persistence," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 29(3), pages 286-99, August.
  14. Fischer, Stanley, 1995. "Central-Bank Independence Revisited," American Economic Review, American Economic Association, American Economic Association, vol. 85(2), pages 201-06, May.
  15. Lippi, Francesco, 1998. " On Central Bank Independence and the Stability of Policy Targets," Scandinavian Journal of Economics, Wiley Blackwell, Wiley Blackwell, vol. 100(2), pages 495-512, June.
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Citations

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Cited by:
  1. Gauti Eggertsson & Eric Le Borgne, 2005. "The politics of central bank independence: a theory of pandering and learning in government," Staff Reports, Federal Reserve Bank of New York 205, Federal Reserve Bank of New York.
  2. Roseline Nyakerario Misati & Esman Morekwa Nyamongo & Lucas Kamau Njoroge & Sheila Kaminchia, 2012. "Feasibility of inflation targeting in an emerging market: evidence from Kenya," Journal of Financial Economic Policy, Emerald Group Publishing, Emerald Group Publishing, vol. 4(2), pages 146-159, June.
  3. Libich, Jan, 2008. "An explicit inflation target as a commitment device," Journal of Macroeconomics, Elsevier, Elsevier, vol. 30(1), pages 43-68, March.
  4. Libich, Jan & Stehlík, Petr, 2010. "Incorporating rigidity and commitment in the timing structure of macroeconomic games," Economic Modelling, Elsevier, Elsevier, vol. 27(3), pages 767-781, May.
  5. JoAnne Morris & Tonny Lybek, 2004. "Central Bank Governance," IMF Working Papers 04/226, International Monetary Fund.
  6. Blanes i Vidal, Jordi & Leaver, Clare, 2011. "Are tenured judges insulated from political pressure?," Journal of Public Economics, Elsevier, Elsevier, vol. 95(7), pages 570-586.
  7. Christopher W. Crowe, 2006. "Goal-Independent Central Banks," IMF Working Papers 06/256, International Monetary Fund.
  8. Crowe, Christopher, 2008. "Goal independent central banks: Why politicians decide to delegate," European Journal of Political Economy, Elsevier, Elsevier, vol. 24(4), pages 748-762, December.

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