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A Political Agency Theory of Central Bank Independence

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  • GAUTI B. EGGERTSSON
  • ERIC LE BORGNE

Abstract

We propose a simple theory to explain why, and under what circumstances, a politician delegates policy tasks to a technocrat in an independent institution and then analyze under what conditions delegation is optimal for society. Our theory builds on Holmstrˆm's (1982, 1999)"hidden effort" principal-agent model. The election pressures that politicians face, and the absence of such pressures for technocrats, give rise to a dynamic incentive structure that formalizes two rationales for delegation, one highlighted by Hamilton (1788) and the other by Blinder (1998). Delegation trades off the cost of having a possibly incompetent technocrat with a long-term job contract against the benefit of having a technocrat who (i) invests more effort into the specialized policy task and (ii) is better insulated from the whims of public opinion. A natural application of our framework suggests a new theory of central bank independence. Copyright (c) 2010 The Ohio State University.

Suggested Citation

  • Gauti B. Eggertsson & Eric Le Borgne, 2010. "A Political Agency Theory of Central Bank Independence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(4), pages 647-677, June.
    • Handle: RePEc:mcb:jmoncb:v:42:y:2010:i:4:p:647-677
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