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The Walsh Contracts for Central Bankers Are Optimal After All!

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  • Georgios E. Chortareas

    (University of Essex)

  • Stephen M. Miller

    (University of Connecticut and University of Nevada, Las Vegas)

Abstract

Candel-Sanchez and Campoy-Minarro (2004) argue that the Walsh linear inflation contract does not prove optimal when the government concerns itself about the cost of the central bank contract. This result relies on the authors. assumption that the participation constraint does not represent an effective constraint on the central banker's decision. Instead, the government can "impose" or "force" the contract on the central banker, even though the contract violates the participation constraint. We argue that such a contract does not make sense. The government can impose it, but it does not affect the central banker's incentives. The policy outcomes do not match those of commitment. Then we show that the Walsh linear inflation contract does produce the optimal outcome, even when the government cares about the cost of the contract.

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Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2006-14.

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Length: 16 pages
Date of creation: Apr 2006
Date of revision:
Publication status: Published in Public Choice, April 2007
Handle: RePEc:uct:uconnp:2006-14

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Keywords: central banks; contracts; Walsh;

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References

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  1. Chortareas, Georgios E & Miller, Stephen M, 2003. " Central Banker Contracts, Incomplete Information, and Monetary Policy Surprises: In Search of a Selfish Central Banker?," Public Choice, Springer, vol. 116(3-4), pages 271-95, September.
  2. 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.
  3. Svensson, Lars E O, 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," CEPR Discussion Papers 1249, C.E.P.R. Discussion Papers.
  4. McCallum, Bennett T., 1997. "Crucial issues concerning central bank independence," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 99-112, June.
  5. Bennett T. McCallum, 1995. "Two Fallacies Concerning Central Bank Independence," NBER Working Papers 5075, National Bureau of Economic Research, Inc.
  6. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
  7. 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.
  8. Francisco Candel-Sánchez & Juan Cristóbal Campoy-Miñarroy, 2004. "Is the Walsh Contract Really Optimal?," Public Choice, Springer, vol. 120(1_2), pages 29-39, 07.
  9. 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.
  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. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  12. Georgios E. Chortareas & Stephen M. Miller, 2003. "Monetary Policy Delegation, Contract Costs and Contract Targets," Bulletin of Economic Research, Wiley Blackwell, vol. 55(1), pages 101-112, January.
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