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Monetary Policy Delegation, Contract Costs, and Contract Targets

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  • Georgios E. Chortareas

    (Bank of England)

  • Stephen M. Miller

    (University of Connecticut)

Abstract

We reconsider the optimal central banker contract derived in Walsh (1995). We show that if the government's objective function places weight (value) on the cost of the contract, then the optimal inflation contract does not completely neutralize the inflation bias. That is, a fraction of the inflation bias emerges in the resulting inflation rate after the central banker's monetary policy decision. Furthermore, the more concerned the government is about the cost of the contract or the less selfish (more benevolent) is the central banker, the smaller is the share of the inflation bias eliminated by the contract. No matter how concerned the government is about the cost of the contract or how unselfish (benevolent) the central banker is, the contract always reduces the inflationary bias by at least half. Finally, a central banker contract written in terms of output (i.e., incorporating an output target) can completely eradicate the inflationary bias, regardless of concerns about contract costs.

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Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2000-01.

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Length: 18 pages
Date of creation: Jan 2000
Date of revision:
Publication status: Published in Bulletin of Economic Research, January 2003
Handle: RePEc:uct:uconnp:2000-01

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Postal: University of Connecticut 341 Mansfield Road, Unit 1063 Storrs, CT 06269-1063
Phone: (860) 486-4889
Fax: (860) 486-4463
Web page: http://www.econ.uconn.edu/
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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. Svensson, L.E.O., 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," Papers 595, Stockholm - International Economic Studies.
  3. Matthew B. Canzoneri, 1983. "Monetary policy games and the role of private information," International Finance Discussion Papers 249, Board of Governors of the Federal Reserve System (U.S.).
  4. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  5. Michelle R. Garfinkel & Seonghwan Oh, 1990. "Strategic discipline in monetary policy with private information: optimal targeting periods," Working Papers 1990-001, Federal Reserve Bank of St. Louis.
  6. Bennett T. McCallum, 1995. "Two Fallacies Concerning Central Bank Independence," NBER Working Papers 5075, National Bureau of Economic Research, Inc.
  7. Bennett T. McCallum, 1996. "Crucial Issues Concerning Central Bank Independence," NBER Working Papers 5597, National Bureau of Economic Research, Inc.
  8. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  9. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
  10. 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.
  11. 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.
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Cited by:
  1. Giuseppe Ciccarone & Enrico Marchetti, 2012. "Optimal linear contracts under common agency and uncertain central bank preferences," Public Choice, Springer, vol. 150(1), pages 263-282, January.
  2. Stephen M. Miller & Huiping Yuan, 2005. "Consistent Targets and Optimal Monetary Policy: Conservative Central Banker Redux," Working papers 2005-55, University of Connecticut, Department of Economics, revised Jan 2009.
  3. Georgios E. Chortareas & Stephen M. Miller, 2006. "The Walsh Contracts for Central Bankers Are Optimal After All!," Working papers 2006-14, University of Connecticut, Department of Economics.
  4. Georgios Chortareas & Stephen Miller, 2007. "The Walsh contract for central bankers proves optimal after all!," Public Choice, Springer, vol. 131(1), pages 243-247, April.
  5. Huiping Yuan & Stephen M. Miller, 2011. "The Optimality and Controllability of Discretionary Monetary Policy," Working papers 2011-17, University of Connecticut, Department of Economics.
  6. Georgios Chortareas & Stephen Miller, 2004. "Optimal Central Banker Contracts and Common Agency," Public Choice, Springer, vol. 121(1), pages 131-155, October.
  7. Huiping Yuan & Stephen M. Miller, 2006. "The Making of Optimal and Consistent Policy: An Implementation Theory Framework for Monetary Policy," Working papers 2006-06, University of Connecticut, Department of Economics, revised Jan 2009.
  8. Georgios E. Chortareas & Stephen M. Miller, 2002. "Central Banker Contracts, Incomplete Information, and Monetary Policy Surprises: In Search of a Selfish Central Banker?," Working papers 2002-29, University of Connecticut, Department of Economics.
  9. Huiping Yuan & Stephen M. Miller & Langnan Chen, 2006. "The Making of Optimal and Consistent Policy: An Analytical Framework for Monetary Models," Working papers 2006-05, University of Connecticut, Department of Economics, revised Jan 2009.
  10. Huiping Yuan & Stephen M. Miller & Langnan Chen, 2009. "The Optimality and Controllability of Monetary Policy through Delegation with Consistent Targets," Working Papers 0909, University of Nevada, Las Vegas , Department of Economics.

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