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Deus ex machina wanted: time inconsistency of time consistency solutions in monetary policy

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Abstract

This paper argues that delegation (optimal institutional design) is not a solution to the dynamic inconcistency problem, and can even reinforce it. We show that 'optimal' delegation is not consistent with government's incentives. We solve for delegation schemes that are consistent with these incentives and find that they imply 'no delegation'. Introducing a cost of reappointing the central banker just postpones the problem, and can only solve it if the government is infinitely averse to changing central bank's contract. Our results hint to: (i) alternative explanations for good anti-inflationary performance; (ii) strengthening central bank independence and (iii) giving a more prominent role to Central Bank reputation building in fighting inflation.

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  • Florin Bilbiie, 2005. "Deus ex machina wanted: time inconsistency of time consistency solutions in monetary policy," Economics Papers 2005-W10, Economics Group, Nuffield College, University of Oxford.
    • Handle: RePEc:nuf:econwp:0510
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