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Designing Monetary Policy When Unemployment Persists

  • Lockwood, Ben
  • Miller, Marcus
  • Zhang, Lei

This paper investigates how unemployment persistence affects the optimal delegation of monetary policy to an independent central banker (CB). Two opposing forces are shown to be at work: with more persistence, the government's incentive to stabilize the economy is greater; but (if the CB is forward-looking) its incentive to create inflation surprises is also greater. The authors show that, owing to the second effect, the government may wish not to delegate at all, unlike the case where there is no persistence. In the event that the government does delegate, the paper identifies conditions under which either effect dominates in the government's choice of conservatism of the CB. The authors compare delegation to discretion and precommitment, using a diagrammatic approach that may be of independent interest. They also present some preliminary empirical evidence on the cross-country relationship between unemployment persistence and inflation that appears consistent with the model's predictions. Copyright 1998 by The London School of Economics and Political Science

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Article provided by London School of Economics and Political Science in its journal Economica.

Volume (Year): 65 (1998)
Issue (Month): 259 (August)
Pages: 327-45

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Handle: RePEc:bla:econom:v:65:y:1998:i:259:p:327-45
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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. Lars E.O. Svensson, 1995. "Optimal Inflation Targets, `Conservative' Central Banks, and Linear Inflation Contracts," NBER Working Papers 5251, National Bureau of Economic Research, Inc.
  3. Lockwood, Ben & Philippopoulos, Apostolis, 1994. "Insider Power, Unemployment Dynamics and Multiple Inflation Equilibria," Economica, London School of Economics and Political Science, vol. 61(241), pages 59-77, February.
  4. Layard, Richard & Nickell, Stephen & Jackman, Richard, 1991. "Unemployment: Macroeconomic Performance and the Labour Market," OUP Catalogue, Oxford University Press, number 9780198284345.
  5. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  6. Alex Cukierman, 1992. "Central Bank Strategy, Credibility, and Independence: Theory and Evidence," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262031981, June.
  7. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  8. 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.
  9. Olivier J. Blanchard & Lawrence H. Summers, 1986. "Hysteresis and the European Unemployment Problem," NBER Working Papers 1950, National Bureau of Economic Research, Inc.
  10. Nelson, Charles R. & Plosser, Charles I., 1982. "Trends and random walks in macroeconmic time series : Some evidence and implications," Journal of Monetary Economics, Elsevier, vol. 10(2), pages 139-162.
  11. 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.
  12. Lindbeck, Assar & Snower, Dennis J, 1986. "Wage Setting, Unemployment, and Insider-Outsider Relations," American Economic Review, American Economic Association, vol. 76(2), pages 235-39, May.
  13. Levine, Paul L & Pearlman, Joseph, 1994. "Labour Market Structure, Conservative Bankers and the Feasibility of Monetary Union," CEPR Discussion Papers 903, C.E.P.R. Discussion Papers.
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