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Delegation of Monetary Policy: More than a Relocation of the Time-Inconsistency Problem

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  • Zeno Rotondi
  • John Driffill

Abstract

It has been argued that delegation of monetary policy to an independent central bank, which acts as an agent for the government, does not mitigate the problem of time-inconsistency, but merely relocates it. We argue here that this is not so, and that delegation enables a wider class of economies to sustain zero inflation than would be able to do so in its absence. We consider an economy in which the government faces re-appointment costs, that is, costs associated with sacking one central banker and replacing them with another, costs which are intended to protect central bank independence. We show that, by means of suitable announcements of incentive schemes for the central bank, combined with appropriate actually implemented schemes, delegated policy enables zero inflation to prevail in economies in which it could not do so without delegated policy. These economies are ones that have relatively high discount rates (and so low discount factors).
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Suggested Citation

  • Zeno Rotondi & John Driffill, 2003. "Delegation of Monetary Policy: More than a Relocation of the Time-Inconsistency Problem," Computing in Economics and Finance 2003 292, Society for Computational Economics.
    • Handle: RePEc:sce:scecf3:292
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    References listed on IDEAS

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    1. 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.
    2. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
    3. Persson, Torsten & Tabellini, Guido, 1999. "Political economics and macroeconomic policy," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 22, pages 1397-1482, Elsevier.
    4. Jensen, Henrik, 1997. "Credibility of Optimal Monetary Delegation," American Economic Review, American Economic Association, vol. 87(5), pages 911-920, December.
    5. Herrendorf, Berthold, 1998. "Inflation Targeting as a Way of Precommitment," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 431-448, July.
    6. Adam S. Posen, 1995. "Declarations Are Not Enough: Financial Sector Sources of Central Bank Independence," NBER Chapters, in: NBER Macroeconomics Annual 1995, Volume 10, pages 253-274, National Bureau of Economic Research, Inc.
    7. McCallum, Bennett T, 1995. "Two Fallacies Concerning Central-Bank Independence," American Economic Review, American Economic Association, vol. 85(2), pages 207-211, May.
    8. McCallum, Bennett T., 1997. "Crucial issues concerning central bank independence," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 99-112, June.
    9. Backus, David & Driffill, John, 1985. "Inflation and Reputation," American Economic Review, American Economic Association, vol. 75(3), pages 530-538, June.
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    Cited by:

    1. António Caleiro, 2004. "Economic Policies and Elections. A principal-agent point of view," Notas Económicas, Faculty of Economics, University of Coimbra, issue 20, pages 89-101, December.
    2. Ullrich, Katrin, 2003. "Unabhängigkeit und Verantwortlichkeit der Europäischen Zentralbank," ZEW Discussion Papers 03-65, ZEW - Leibniz Centre for European Economic Research.

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    More about this item

    Keywords

    credibility; delegation; time-inconsistency; independent central banks; monetary policy;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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