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Inflation Targets and Contracts with Uncertain Central Banker Preferences

  • Beetsma, Roel M W J
  • Jensen, Henrik

Within a standard model of monetary delegation the authors show that the optimal linear inflation contract performs strictly better than the optimal inflation target when there is uncertainty about the central banker's preferences. The optimal combination of a contract and a target performs best and eliminates the inflation bias and any variability not associated with supply shocks. However, variability due to shocks is enhanced by uncertain central banker preferences. Quadratic contracts are shown to overcome this problem partly, but the advantages of delegation may still be dominated by the 'excess variability' due to shocks. Hence, the credibility-stabilization tradeoff is restored.

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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 30 (1998)
Issue (Month): 3 (August)
Pages: 384-403

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Handle: RePEc:mcb:jmoncb:v:30:y:1998:i:3:p:384-403
Contact details of provider: Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Carl E. Walsh, 1994. "Is New Zealand's Reserve Bank Act of 1989 an optimal central bank contract?," Pacific Basin Working Paper Series 94-01, Federal Reserve Bank of San Francisco.
  2. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  3. Herrendorf, Berthold & Lockwood, Ben, 1996. "Rogoff's 'Conservative' Central Banker Restored," CEPR Discussion Papers 1386, C.E.P.R. Discussion Papers.
  4. Lockwood, Ben & Miller, Marcus & Zhang, Lei, 1998. "Designing Monetary Policy When Unemployment Persists," Economica, London School of Economics and Political Science, vol. 65(259), pages 327-45, August.
  5. Stanley Fischer, 1995. "Modern Approaches to Central Banking," NBER Working Papers 5064, National Bureau of Economic Research, Inc.
  6. 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.
  7. Alesina, Alberto & Gatti, Roberta, 1995. "Independent Central Banks: Low Inflation at No Cost?," American Economic Review, American Economic Association, vol. 85(2), pages 196-200, May.
  8. Thomas Havrilesky & John Gildea, 1991. "Screening Fomc Members For Their Biases And Dependability," Economics and Politics, Wiley Blackwell, vol. 3(2), pages 139-149, 07.
  9. David Backus & John Driffill, 1984. "Inflation and Reputation," Working Papers 560, Queen's University, Department of Economics.
  10. Waller, Christopher J & Walsh, Carl E, 1996. "Central-Bank Independence, Economic Behavior, and Optimal Term Lengths," American Economic Review, American Economic Association, vol. 86(5), pages 1139-53, December.
  11. 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.
  12. Cukierman, Alex & Meltzer, Allan H, 1986. "A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information," Econometrica, Econometric Society, vol. 54(5), pages 1099-1128, September.
  13. Lossani, Marco & Natale, Piergiovanna & Tirelli, Patrizio, 1998. "Incomplete Information in Monetary Policy Games: Rules Rather Than a Conservative Central Banker," Scottish Journal of Political Economy, Scottish Economic Society, vol. 45(1), pages 33-47, February.
  14. 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.
  15. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
  16. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, June.
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