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An Independent Central Bank faced with Elected Government: A Political Economy Conflict

  • M. Demertzis
  • A. Hughes Hallett
  • N. Viegi

The literature argues that the benefits of an independent Central Bank accrue at no cost to the real side. In this paper, we argue that the lack of correlation between monetary autonomy and output variability, is due to the proactive role of fiscal policy when faced with rigid monetary objectives. Few of the attempts to measure these correlations actually allow for a changing fiscal role. Yet, when monetary policy is handled by an independent authority, fiscal and wage/social protection policies remain as an instrument in the hands of elected governments. We find that, so long as the two authorities pursue their goals independently of each other, a conflict arises which becomes stronger as preferences diverge. Further to that, we find that the establishment of a conservative Central Bank encourages more divergent preferences amongst the public (as reflected in the governments they elect). The election of more interventionist governments then makes it harder for either authority to reach their own preferred objectives, unless they are able to co-operate.

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Paper provided by Netherlands Central Bank, Research Department in its series WO Research Memoranda (discontinued) with number 686.

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Date of creation: May 2002
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Handle: RePEc:dnb:wormem:686
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