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Institutional Design and Credibility

Author

Listed:
  • Jyotsana Kala

    (JPMorgan Chase and Co.)

  • Naveen Srinivasan

    ((Corresponding author) Professor, Madras School of Economics, Chennai, India)

Abstract

The optimal design of a monetary institution to achieve policy effectiveness has been of utmost importance to policy-makers. This paper presents an empirical analysis of the link between the structure of a monetary institution and inflation persistence in an economy. It is well established in literature that governance structure of a monetary institution affects the stability of an economy. But the mechanism by which it operates remains unclear. In this paper, we claim this mechanism to be the credibility of the monetary institution. A Central Bank with an autonomous and transparent governance structure is deemed to be more credible by agents, which in turn leads to higher inflation stability in the economy. We investigate this hypothesis using data for the UK. Our results suggest that credibility is the missing link. The institutional design of the Central Bank contributes to its credibility, which subsequently affects the degree of inflation persistence in the economy.

Suggested Citation

  • Jyotsana Kala & Naveen Srinivasan, 2020. "Institutional Design and Credibility," Working Papers 2020-193, Madras School of Economics,Chennai,India.
    • Handle: RePEc:mad:wpaper:2020-193
    as

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    References listed on IDEAS

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    More about this item

    Keywords

    Divisia; central bank; central bank independence; inflation persistence; monetary policy credibility; policy making; time-inconsistency;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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