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A non-Normative Theory of Inflation and Central Bank Independence

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  • Herrendorf, B.
  • Neumann, M.J.M.

Abstract

We study monetary policy under different central bank constitutions when the labor-market insiders set the nominal wage so that outsiders are involuntarily unemployed. If the insiders are in the majority, the representative insider will be the median voter. We show that an independent central bank, if controlled by the median voter, does not produce a systematic inflation bias, albeit equilibrium employment is too low from a social welfare point of view. A dependent central bank, in contrast, is forced by the government to collect seigniorage and to take the government's re-election prospects into account. The predictions of our theory are consistent with the evidence that central bank independence decreases average inflation and inflation variability, but does not affect employment variability.

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File URL: http://www2.warwick.ac.uk/fac/soc/economics/research/workingpapers/2008/paper.pdf
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Bibliographic Info

Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 515.

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Length: 20 pages
Date of creation: 1998
Date of revision:
Handle: RePEc:wrk:warwec:515

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Keywords: INFLATION ; MONETARY POLICY ; CENTRAL BANKS;

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References

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  1. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," NBER Working Papers 1950, National Bureau of Economic Research, Inc.
  2. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
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  4. Coenen, Günter & Orphanides, Athanasios & Wieland, Volker, 2003. "Price stability and monetary policy effectiveness when nominal interest rates are bounded at zero," Working Paper Series 0231, European Central Bank.
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  6. Kenneth Rogoff & Anne Sibert, 1986. "Elections and Macroeconomic Policy Cycles," NBER Working Papers 1838, National Bureau of Economic Research, Inc.
  7. Svensson, L.E.O., 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," Papers 595, Stockholm - International Economic Studies.
  8. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, December.
  9. Unknown, 1998. "Discussion," Journal of Economic Psychology, Elsevier, vol. 19(5), pages 619-643, October.
  10. Eijffinger, S.C.W. & Schaling, E. & Hoeberichts, M.M., 1997. "Central Bank independence: A sensitivity analysis," Discussion Paper 1997-10, Tilburg University, Center for Economic Research.
  11. Richard H. Clarida & Mark Gertler, 1997. "How the Bundesbank Conducts Monetary Policy," NBER Chapters, in: Reducing Inflation: Motivation and Strategy, pages 363-412 National Bureau of Economic Research, Inc.
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  13. Fratianni, Michele & von Hagen, Jurgen & Waller, Christopher J, 1997. "Central Banking as a Political Principal-Agent Problem," Economic Inquiry, Western Economic Association International, vol. 35(2), pages 378-93, April.
  14. Berger, Helge & Woitek, Ulrich, 1997. "How opportunistic are partisan German central bankers: Evidence on the Vaubel hypothesis," European Journal of Political Economy, Elsevier, vol. 13(4), pages 807-821, December.
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  16. Vaubel, Roland, 1997. "The bureaucratic and partisan behavior of independent central banks: German and international evidence," European Journal of Political Economy, Elsevier, vol. 13(2), pages 201-224, May.
  17. Jon Faust, 1992. "Whom can we trust to run the Fed? Theoretical support for the founders' views," International Finance Discussion Papers 429, Board of Governors of the Federal Reserve System (U.S.).
  18. Herrendorf, Berthold & Lockwood, Ben, 1997. "Rogoff's "Conservative" Central Banker Restored," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 29(4), pages 476-95, November.
  19. Manfred Neumann, 1991. "Precommitment by central bank independence," Open Economies Review, Springer, vol. 2(2), pages 95-112, June.
  20. José Angulo & N. Cressie & C. Wikle & P. Soidán & M. Bande & C. Glasbey & John Kent & Ana Militino & Michael Stein, 1998. "Discussion," TEST: An Official Journal of the Spanish Society of Statistics and Operations Research, Springer, vol. 7(2), pages 283-285, December.
  21. Grier, Kevin B., 1991. "Congressional influence on U.S. monetary policy : An empirical test," Journal of Monetary Economics, Elsevier, vol. 28(2), pages 201-220, October.
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Cited by:
  1. Herrendorf, Berthold & Neumann, Manfred J.M., 1998. "The Political Economy of Inflation, Labour Market Distortions and Central Bank Independence," CEPR Discussion Papers 1969, C.E.P.R. Discussion Papers.
  2. Berlemann, Michael & Markwardt, Gunther, 2003. "Partisan cycles and pre-electoral uncertainty," Dresden Discussion Paper Series in Economics 01/03, Dresden University of Technology, Faculty of Business and Economics, Department of Economics.

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