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Delegation of Monetary Policy: More than a Relocation of the Time-Inconsistency Problem

  • Driffill, John
  • Rotondi, Zeno

It has been argued that delegation of monetary policy to an independent central bank, which acts as an agent for the government, does not mitigate the problem of time-inconsistency, but merely relocates it. We argue here that this is not so, and that delegation enables a wider class of economies to sustain zero inflation than would be able to do so in its absence. We consider an economy in which the government faces re-appointment costs, that is, costs associated with sacking one central banker and replacing them with another, costs which are intended to protect central bank independence. We show that, by means of suitable announcements of incentive schemes for the central bank, combined with appropriate actually implemented schemes, delegated policy enables zero inflation to prevail in economies in which it could not do so without delegated policy. These economies are ones that have relatively high discount rates (and so low discount factors).

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3923.

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Date of creation: Jun 2003
Date of revision:
Handle: RePEc:cpr:ceprdp:3923
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  1. Herrendorf, Berthold, 1998. "Inflation Targeting as a Way of Precommitment," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 431-48, July.
  2. Torsten Persson & Guido Tabellini, . "Political Economics and Macroeconomic Policy," Working Papers 121, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  3. Backus, David & Driffill, John, 1985. "Inflation and Reputation," American Economic Review, American Economic Association, vol. 75(3), pages 530-38, June.
  4. Bennett T. McCallum, 1996. "Crucial Issues Concerning Central Bank Independence," NBER Working Papers 5597, National Bureau of Economic Research, Inc.
  5. Adam S. Posen, 1995. "Declarations Are Not Enough: Financial Sector Sources of Central Bank Independence," NBER Chapters, in: NBER Macroeconomics Annual 1995, Volume 10, pages 253-274 National Bureau of Economic Research, Inc.
  6. Bennett T. McCallum, 1995. "Two Fallacies Concerning Central Bank Independence," NBER Working Papers 5075, National Bureau of Economic Research, Inc.
  7. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  8. Jensen, Henrik, 1997. "Credibility of Optimal Monetary Delegation," American Economic Review, American Economic Association, vol. 87(5), pages 911-20, December.
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