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Institutional Arrangements for Monetary Policy When Output Is Persistent

  • Roisland, Oistein

A discretionary monetary policy gives rise to a constant average inflation bias, a state-contingent inflation bias, and a stabilization bias when output is persistent. The paper considers institutional arrangements ("contracts") for central banks that remove these policy imperfections. The average and state-contingent inflation biases can be removed by directing the central bank to target the growth of nominal income and appoint a central banker with a specific relative weight attached to output stabilization. An alternative to this institutional solution is to direct central banks to aim for a feasible output target. Although this would remove the inflationary biases, the government must appoint a "liberal" (as opposed to "conservative") central banker in order to implement optimal stabilization.

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

Volume (Year): 33 (2001)
Issue (Month): 4 (November)
Pages: 994-1014

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Handle: RePEc:mcb:jmoncb:v:33:y:2001:i:4:p:994-1014
Contact details of provider: Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Bennett T. McCallum, 1997. "The alleged instability of nominal income targeting," Reserve Bank of New Zealand Discussion Paper Series G97/6, Reserve Bank of New Zealand.
  2. Svensson, L-E-O, 1997. "Inflation Targeting : Some Extensions," Papers 625, Stockholm - International Economic Studies.
  3. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-86, March.
  4. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, vol. 100(4), pages 1169-1189.
  5. Koenig, Evan F., 1996. "Targeting nominal income: A closer look," Economics Letters, Elsevier, vol. 51(1), pages 89-93, April.
  6. Glenn Rudebusch, 2000. "Assessing Nominal Income Rules for Monetary Policy with Model and Data Uncertainty," Econometric Society World Congress 2000 Contributed Papers 0065, Econometric Society.
  7. Bennett T. McCallum & Edward Nelson, . "Performance of Operational Policy Rules in an Estimated Semi-Classical Structural Model," GSIA Working Papers 1998-22, Carnegie Mellon University, Tepper School of Business.
  8. Durlauf, Steven N., 1993. "Time series properties of aggregate output fluctuations," Journal of Econometrics, Elsevier, vol. 56(1-2), pages 39-56, March.
  9. Lockwood, B. & Miller, M. & Zhang, L., 1994. "Designing Monetary Policy when Unemployment Persists," Discussion Papers 9408, Exeter University, Department of Economics.
  10. Frankel, Jeffrey, 1995. "The Stabilizing Properties of a Nominal GNP Rule," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(2), pages 318-34, May.
  11. Bean, Charles R, 1983. "Targeting Nominal Income: An Appraisal," Economic Journal, Royal Economic Society, vol. 93(372), pages 806-19, December.
  12. Robert J. Barro & David B. Gordon, 1981. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  13. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 893-920, October.
  14. Ugo Panizza, 1997. "Optimal Contracts for Central Bankers: Inflation versus Money Supply and Exchange Rate Targets," Open Economies Review, Springer, vol. 8(1), pages 5-29, January.
  15. Matthew B. Canzoneri, 1983. "Monetary policy games and the role of private information," International Finance Discussion Papers 249, Board of Governors of the Federal Reserve System (U.S.).
  16. Roel M.W.J. Beetsma & Henrik Jensen, . "Optimal Inflation Targets, “Conservative” Central Banks, and Linear Inflation Contracts: Comment," EPRU Working Paper Series 98-11, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  17. Dennis, Richard, 2001. "Inflation Expectations and the Stability Properties of Nominal GDP Targeting," Economic Journal, Royal Economic Society, vol. 111(468), pages 103-13, January.
  18. Martin Feldstein & James H. Stock, 1994. "The Use of a Monetary Aggregate to Target Nominal GDP," NBER Chapters, in: Monetary Policy, pages 7-69 National Bureau of Economic Research, Inc.
  19. Steven N. Durlauf, 1989. "Output Persistence, Economic Structure, and the Choice of Stabilization Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(2), pages 69-136.
  20. 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.
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