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A Prudent Central Banker

  • RUGE-MURCIA, Francisco J.

This paper studies monetary policy in an economy where the central banker's preferences are asymmetric around optimal inflation. In particular, positive deviations from the optimum can be weighted more, or less, severely than negative deviations in the policy maker's loss function. It is shown that under asymmetric preferences, uncertainty can induce a prudent behavior on the part of the central banker. Since the prudence motive can be large enough to override the inflation bias, optimal monetary policy could be implemented even in the absence of rules, reputation, or contractual mechanisms. For certain parameter values, a deflationary bias can arise in equilibrium.

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File URL: http://hdl.handle.net/1866/348
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Paper provided by Universite de Montreal, Departement de sciences economiques in its series Cahiers de recherche with number 2001-07.

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Length: 18 pages
Date of creation: 2001
Date of revision:
Handle: RePEc:mtl:montde:2001-07
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  1. Granger, C.W.J. & Pesaran, H., 1996. "A Decision_Theoretic Approach to Forecast Evaluation," Cambridge Working Papers in Economics 9618, Faculty of Economics, University of Cambridge.
  2. Gul, Faruk, 1991. "A Theory of Disappointment Aversion," Econometrica, Econometric Society, vol. 59(3), pages 667-86, May.
  3. Francisco Javier Ruge-Murcia, 2001. "Inflation Targeting Under Asymmetric Preferences," IMF Working Papers 01/161, International Monetary Fund.
  4. Svensson, L.E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Papers 646, Stockholm - International Economic Studies.
  5. Muscatelli, V Anton, 1999. "Inflation Contracts and Inflation Targets under Uncertainty: Why We Might Need Conservative Central Bankers," Economica, London School of Economics and Political Science, vol. 66(262), pages 241-54, May.
  6. Beetsma, Roel M W J & Jensen, Henrik, 1998. "Inflation Targets and Contracts with Uncertain Central Banker Preferences," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(3), pages 384-403, August.
  7. Richard Clarida & Jordi Gali & Mark Gertler, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," NBER Working Papers 7147, National Bureau of Economic Research, Inc.
  8. Persson, Torsten & Tabellini, Guido, 1993. "Designing institutions for monetary stability," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 53-84, December.
  9. repec:dgr:kubcen:199747 is not listed on IDEAS
  10. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
  11. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  12. Peter N. Ireland, 1998. "Does the Time-Consistency Problem Explain the Behavior of Inflation in the United States?," Boston College Working Papers in Economics 415, Boston College Department of Economics.
  13. Lars E.O. Svensson, 1995. "Optimal Inflation Targets, `Conservative' Central Banks, and Linear Inflation Contracts," NBER Working Papers 5251, National Bureau of Economic Research, Inc.
  14. Caballero, R.J., 1988. "Consumption Puzzles And Precautionary Savings," Discussion Papers 1988_05, Columbia University, Department of Economics.
  15. Bennett T. McCallum, 1995. "Two Fallacies Concerning Central Bank Independence," NBER Working Papers 5075, National Bureau of Economic Research, Inc.
  16. Ruge-Murcia, F.J., 1998. "Uncovering Financial Markets Beliefs About Inflation Targets," Cahiers de recherche 9803, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
  17. Peter F. Christoffersen & Francis X. Diebold, 1994. "Optimal Prediction Under Asymmetric Loss," NBER Technical Working Papers 0167, National Bureau of Economic Research, Inc.
  18. 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.
  19. 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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