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A Non-normative Theory of Inflation and Central Bank Independence

  • Herrendorf, Berthold
  • Manfred J. M. Neumann

We study monetary policy when the labor-market insiders set the wage so that the outsiders are involuntarily unemployed. If the insiders are in the majority, the representative insider will be the median voter. Consequently, neither an independent nor a government-dependent central banker is found to produce a systematic inflation bias, albeit equilibrium employment is too low from a social welfare point of view. The disadvantage of government-dependence is that the central bank takes the government's reelection prospects into account and creates a political cycle in inflation. Our theory is consistent with the main stylized facts that a higher degreee of central bank independence decreases average inflation and inflation variability, but does not affect output variability.

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Paper provided by University of Bonn, Germany in its series Discussion Paper Serie B with number 400.

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Length: pages
Date of creation: Jan 1997
Date of revision:
Handle: RePEc:bon:bonsfb:400
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Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany

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