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Central Bank Independence and the `Free Lunch Puzzle': A New Perspective

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Author Info
Ali al-Nowaihi (University of Leicester)
Paul Levine (University of Surrey)
Alex Mandilaras (University of Surrey)

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Abstract

A new perspective is provided on a puzzle that has emerged from the empirical lit- erature suggesting that government-independent central banks provide a `free lunch': lower in°ation is apparently achieved at no cost in terms of greater output variance. We assess the various explanations provided by the theoretical literature. After revis- iting the free lunch puzzle and con¯rming the empirical importance of open-economy effects, we develop a Rogoff-style delegation model that combines the latter with po- litical monetary cycle e®ects. We show that if all countries delegate monetary policy to government independent banks, as economies become more integrated then a low inflation, higher output variance trade-off re-emerges.

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Publisher Info
Paper provided by Department of Economics, University of Surrey in its series Department of Economics Discussion Papers with number 0806.

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Length: 31 pages
Date of creation: Mar 2006
Date of revision:
Handle: RePEc:sur:surrec:0806

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Related research
Keywords: central bank independence; open economy; political uncertainty;

Find related papers by JEL classification:
C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
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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  1. Demertzis, Maria & Hughes Hallett, Andrew & Viegi, Nicola, 2004. "An independent central bank faced with elected governments," European Journal of Political Economy, Elsevier, vol. 20(4), pages 907-922, November. [Downloadable!] (restricted)
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  2. 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. [Downloadable!] (restricted)
  3. Beetsma, Roel & Bovenberg, A Lans, 2003. "Political Shocks, Public Debt and the Design of Monetary and Fiscal Institutions," CEPR Discussion Papers 3753, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  4. Currie, David & Levine, Paul & Pearlman, Joseph, 1996. "The Choice of 'Conservative' Bankers in Open Economies: Monetary Regime Options for Europe," Economic Journal, Royal Economic Society, vol. 106(435), pages 345-58, March. [Downloadable!] (restricted)
  5. Missale, Alessandro & Blanchard, Olivier Jean, 1994. "The Debt Burden and Debt Maturity," American Economic Review, American Economic Association, vol. 84(1), pages 309-19, March.
    Other versions:
  6. repec:fth:tilbur:99108 is not listed on IDEAS
  7. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March. [Downloadable!] (restricted)
  8. Marta Campillo & Jeffrey A. Miron, 1996. "Why Does Inflation Differ Across Countries?," NBER Working Papers 5540, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Beetsma, Roel & Bovenberg, A Lans, 1999. "Inflation Targets and Debt Accumulation in a Monetary Union," CEPR Discussion Papers 2324, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  10. Andrew Hughes Hallett & Diana N. Weymark, 2005. "Independence Before Conservatism: Transparency, Politics and Central Bank Design," German Economic Review, Blackwell Publishing, vol. 6(1), pages 1-21, 02. [Downloadable!] (restricted)
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  11. Eijffinger, Sylvester C W & Hoeberichts, Marco, 1998. "The Trade off between Central Bank Independence and Conservativeness," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 397-411, July.
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  12. McCallum, Bennett T, 1995. "Two Fallacies Concerning Central-Bank Independence," American Economic Review, American Economic Association, vol. 85(2), pages 207-11, May. [Downloadable!] (restricted)
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  13. al-Nowaihi, Ali & Levine, Paul, 1998. "Can political monetary cycles be avoided?," Journal of Monetary Economics, Elsevier, vol. 42(3), pages 525-545, October. [Downloadable!] (restricted)
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  14. Alesina, Alberto & Summers, Lawrence H, 1993. "Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(2), pages 151-62, May. [Downloadable!] (restricted)
  15. Cukierman, Alex & Webb, Steven B & Neyapti, Bilin, 1992. "Measuring the Independence of Central Banks and Its Effect on Policy Outcomes," World Bank Economic Review, Oxford University Press, vol. 6(3), pages 353-98, September.
  16. Mandilaras, Alexandros & Levine, Paul, 2001. "Public Debt and Inflation: The Role of Inflation-Sensitive Instruments," Manchester School, University of Manchester, vol. 69(0), pages 1-21, Supplemen. [Downloadable!] (restricted)
  17. Romer, David, 1993. "Openness and Inflation: Theory and Evidence," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 869-903, November. [Downloadable!] (restricted)
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