Deus ex machina wanted: time inconsistency of time consistency solutions in monetary policy

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Deus ex machina wanted: time inconsistency of time consistency solutions in monetary policy

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Florin Bilbiie () (Nuffield College, Oxford and CEP, London School of Economics and EUI, Florence)

Additional information is available for the following registered author(s):

Florin O. Bilbiie

Abstract

This paper argues that delegation (optimal institutional design) is not a solution to the dynamic inconcistency problem, and can even reinforce it. We show that 'optimal' delegation is not consistent with government's incentives. We solve for delegation schemes that are consistent with these incentives and find that they imply 'no delegation'. Introducing a cost of reappointing the central banker just postpones the problem, and can only solve it if the government is infinitely averse to changing central bank's contract. Our results hint to: (i) alternative explanations for good anti-inflationary performance; (ii) strengthening central bank independence and (iii) giving a more prominent role to Central Bank reputation building in fighting inflation.

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Publisher Info
Paper provided by Economics Group, Nuffield College, University of Oxford in its series Economics Papers with number 2005-W10.

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Length: 16 pages
Date of creation: 10 Mar 2005
Date of revision:
Handle: RePEc:nuf:econwp:0510

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Web page: http://www.nuff.ox.ac.uk/economics/

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This paper has been announced in the following NEP Reports:

NEP-ALL-2006-03-18 (All new papers)
NEP-CBA-2006-03-18 (Central Banking)
NEP-MAC-2006-03-18 (Macroeconomics)
NEP-MON-2006-03-18 (Monetary Economics)

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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. [Downloadable!] (restricted)
Other versions:
- Robert J. Barro & David B. Gordon, 1984. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," Journal of Economic Literature, American Economic Association, vol. 37(4), pages 1661-1707, December. [Downloadable!] (restricted)
Other versions:
- Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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Other versions:
- Robert J. Barro & David B. Gordon, 1983. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
Lockwood, Ben & Miller, Marcus & Zhang, Lei, 1998. "Designing Monetary Policy When Unemployment Persists," Economica, London School of Economics and Political Science, vol. 65(259), pages 327-45, August. [Downloadable!] (restricted)
Other versions:
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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.
Other versions:
- Guy Debelle & Stanley Fischer, 1994. "How independent should a central bank be?," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 195-225. [Downloadable!]
Woodford, Michael, 2000. "Optimal Monetary Policy Inertia," Seminar Papers 666, Stockholm University, Institute for International Economic Studies. [Downloadable!]
Other versions:
- Woodford, M., 1999. "Optimal Monetary Policy Inertia.," Papers 666, Stockholm - International Economic Studies.
- Michael Woodford, 1999. "Optimal Monetary Policy Inertia," NBER Working Papers 7261, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
- Michael Woodford, 1999. "Optimal monetary policy inertia," Proceedings, Federal Reserve Bank of San Francisco.
- Woodford, Michael, 1999. "Optimal Monetary Policy Inertia," Manchester School, University of Manchester, vol. 67(0), pages 1-35, Supplemen. [Downloadable!] (restricted)
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. [Downloadable!] (restricted)
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. [Downloadable!] (restricted)
Jensen, Henrik, 1997. "Credibility of Optimal Monetary Delegation," American Economic Review, American Economic Association, vol. 87(5), pages 911-20, December. [Downloadable!] (restricted)

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