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Central Banker Contracts, Incomplete Information, and Monetary Policy Surprises: In Search of a Selfish Central Banker?

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  • Chortareas, Georgios E
  • Miller, Stephen M

Abstract

Approaching monetary policy as a principal-agent problem provides a useful framework for interpreting alternative delegation schemes. In this paper, we consider the effectiveness of central banker incentive schemes when the principal delegates monetary policy through contracts but remains uncertain about the central banker's responsiveness to such schemes. We adopt a simple principal-agent model and assume that the central banker's trade-off between social welfare and the incentive scheme is private information. We consider two types of central bankers; one who responds to the incentive scheme ("selfish") and one who does not and only cares about social welfare ("benevolent"). We demonstrate that when a benevolent central banker accepts a contract designed for a selfish central banker, positive inflation surprises occur and output exceeds its natural rate. We further show that a benevolent central banker with an inflation bias has an incentive to masquerade as selfish. Mechanisms exist that solve that problem by achieving preference revelation. We consider a simple mechanism in dominant strategies that induces the benevolent type either not to breach or not to accept the appointment (contract) in the first place. This multi-period mechanism works with either inflation targets, or the appointment of a conservative central banker. Our results suggest that more complicated incentive schemes, embedded within broader constitutional arrangements, are required in the presence of private information for them to work effectively. Copyright 2003 by Kluwer Academic Publishers

Suggested Citation

  • 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 271-295, September.
    • Handle: RePEc:kap:pubcho:v:116:y:2003:i:3-4:p:271-95
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    Cited by:

    1. Giuseppe Ciccarone & Enrico Marchetti, 2008. "Linear Contracts, Common Agency and Central Bank Preference Uncertainty," Working Papers in Public Economics 115, Department of Economics and Law, Sapienza University of Roma.
    2. Georgios Chortareas & David Stasavage & Gabriel Sterne, 2003. "Does monetary policy transparency reduce disinflation costs?," Manchester School, University of Manchester, vol. 71(5), pages 521-540, September.
    3. Meixing Dai & Eleftherios Spyromitros, 2010. "Accountability And Transparency About Central Bank Preferences For Model Robustness," Scottish Journal of Political Economy, Scottish Economic Society, vol. 57(2), pages 212-237, May.
    4. Dai, Meixing & Spyromitros, Eleftherios, 2012. "Inflation contract, central bank transparency and model uncertainty," Economic Modelling, Elsevier, vol. 29(6), pages 2371-2381.
    5. Masciandaro, Donato, 2022. "Independence, conservatism, and beyond: Monetary policy, central bank governance and central banker preferences (1981–2021)," Journal of International Money and Finance, Elsevier, vol. 122(C).
    6. Marine Charlotte André & Meixing Dai, 2017. "Can inflation contract discipline central bankers when agents are learning?," Working Papers of BETA 2017-25, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    7. Carolina Guerini & Donato Masciandaro & Alessia Papini, 2025. "Literacy and Financial Education: Private Providers, Public Certification and Political Preferences," Italian Economic Journal: A Continuation of Rivista Italiana degli Economisti and Giornale degli Economisti, Springer;Società Italiana degli Economisti (Italian Economic Association), vol. 11(2), pages 463-514, July.
    8. 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.
    9. 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.

    More about this item

    JEL classification:

    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • 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

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