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Time-inconsistency and expansionary business cycle theories: What does matter for the central bank independence–inflation relationship?

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  • Ftiti, Zied
  • Aguir, Abdelkader
  • Smida, Mounir

Abstract

Since the seminal paper of Kydland and Prescott (1977), a central bank’s independence (CBI) has been considered an important institutional condition for achieving lower inflation. Recently, however, this long-held belief has been challenged. This paper investigates the relationship between CBI and inflation for a large sample (91 countries) covering the period from 1990 to 2014. We follow the previous literature by considering differences across national monetary regimes in explaining this relationship. Our approach also traces the sources of the inflationary phenomenon. Using panel data and the turnover indicator as a proxy for CBI, we offer two main findings. First, we identify the role of exchange rate regimes in the dynamic between inflation and CBI. Second, our results show that only intermediate and flexible exchange rate regimes are appropriate in this relationship. This finding is explained by the level of CBI, which is very low for countries with a fixed exchange rate policy and low income levels. For policymakers, our results highlight the importance of the choice of monetary regime in controlling inflation in the presence of CBI. For public agents, our results provide guidelines for formulating expectations.

Suggested Citation

  • Ftiti, Zied & Aguir, Abdelkader & Smida, Mounir, 2017. "Time-inconsistency and expansionary business cycle theories: What does matter for the central bank independence–inflation relationship?," Economic Modelling, Elsevier, vol. 67(C), pages 215-227.
  • Handle: RePEc:eee:ecmode:v:67:y:2017:i:c:p:215-227
    DOI: 10.1016/j.econmod.2016.12.013
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    Cited by:

    1. repec:cbk:journl:v:7:y:2018:i:3:p:91-110 is not listed on IDEAS
    2. Donato Masciandaro & Davide Romelli, 2019. "Behavioral Monetary Policymaking: Economics, Political Economy and Psychology," World Scientific Book Chapters,in: Behavioral Finance The Coming of Age, chapter 9, pages 285-329 World Scientific Publishing Co. Pte. Ltd..

    More about this item

    Keywords

    exchange rate regime; monetary policy; turnover; income level; panel data;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • 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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