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Institution Design for Macroeconomic Policy

Author

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  • Alexander Mihailov

    () (Department of Economics, University of Reading)

  • Katrin Ullrich

    () (KfW Bankengruppe, Frankfurt (Main))

Abstract

This paper explores the normative aspects of the institution design for macroeconomic policymaking when a society legislates specific objectives and sequencing of decisions for the involved authorities. We develop a general theoretical framework that adds fiscal policy to the flexibility-credibility trade-off well-established in monetary policy. We find that delegation of both monetary and fiscal policy to autonomous institutions of appointed experts improves macroeconomic outcomes by delivering lower average in flation and lower average public-sector deficit-to-output ratio over alternative policies conducted with interference by elected politicians. Yet greater independence of monetary and fiscal policymakers from the government also generates increased output variability around normal output. The latter effect is minor in magnitude, and the simulated expected social losses in all considered 24 institution-design regimes demonstrate the long-run welfare dominance of delegation of both monetary and fiscal policy to independent expert committees over joint government optimization. In addition, preannouncing an escape clause to be activated following extreme negative shocks may help mitigate short-run output and employment fluctuations, but at the cost of expected social losses that rise considerably.

Suggested Citation

  • Alexander Mihailov & Katrin Ullrich, 2015. "Institution Design for Macroeconomic Policy," Economics & Management Discussion Papers em-dp2015-01, Henley Business School, Reading University.
  • Handle: RePEc:rdg:emxxdp:em-dp2015-01
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    File URL: http://www.reading.ac.uk/web/FILES/economics/emdp2015116.pdf
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    References listed on IDEAS

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    1. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, vol. 100(4), pages 1169-1189.
    2. Lohmann, Susanne, 1992. "Optimal Commitment in Monetary Policy: Credibility versus Flexibility," American Economic Review, American Economic Association, vol. 82(1), pages 273-286, March.
    3. Pierpaolo Benigno & Michael Woodford, 2004. "Optimal Monetary and Fiscal Policy: A Linear-Quadratic Approach," NBER Chapters,in: NBER Macroeconomics Annual 2003, Volume 18, pages 271-364 National Bureau of Economic Research, Inc.
    4. Mihov, Ilian & Sibert, Anne, 2006. "Credibility and Flexibility with Independent Monetary Policy Committees," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(1), pages 23-46, February.
    5. Jürgen von Hagen & Susanne Mundschenk, 2003. "Fiscal and monetary policy coordination in EMU," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 8(4), pages 279-295.
    6. Gianluca Benigno & Bianca De Paoli, 2010. "On the International Dimension of Fiscal Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(8), pages 1523-1542, December.
    7. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    8. Matthew B. Canzoneri & Dale W. Henderson, 1991. "Monetary Policy in Interdependent Economies: A Game-Theoretic Approach," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262031787, March.
    9. Phelps, Edmund S & Taylor, John B, 1977. "Stabilizing Powers of Monetary Policy under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 163-190, February.
    10. Francesca Castellani & Xavier Debrun, 2001. "Central Bank Independence and the Design of Fiscal Institutions," IMF Working Papers 01/205, International Monetary Fund.
    11. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-167, March.
    12. 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 473-491, June.
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    More about this item

    Keywords

    delegation; independence; expert committees; monetary-fiscal interactions; policy games; institution design;

    JEL classification:

    • E02 - Macroeconomics and Monetary Economics - - General - - - Institutions and the Macroeconomy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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