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Linear Contracts, Common Agency and Central Bank Preference Uncertainty

  • Giuseppe Ciccarone
  • Enrico Marchetti

The aim of this paper is to bring together two recent developments in the â€contracting†approach to the time-inconsistency problem of monetary policy: linear contracts under common agency and central bank preference uncertainty under single agency. We show that under common agency and imperfect â€political†transparencey, the full transparency finding that the interest group contract dominates the government’s one is confirmed, but equilibrium expected inflation is lower, as the new source of uncertainty makes the two principals more cautious in their instrument setting. This reduces the average inflation bias. We then extend the analysis to the case of uncertainty on the central bank output target and show that the expected values of inflation and output are the same as those obtained under perfect â€economic†transparency, whereas the actual values are different only for the presence of an additive term depending on opacity. Finally, we demonstrate that when the principals are uncertain about the weight attached by the central banker to the incentive scheme the equilibrium inflation surprise may be negative and output may be lower than the natural rate.

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Paper provided by University of Rome La Sapienza, Department of Public Economics in its series Working Papers with number 115.

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Length: 27
Date of creation: Dec 2008
Date of revision:
Handle: RePEc:sap:wpaper:wp115
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  28. Petra M. Geraats, 2002. "Central Bank Transparency," Economic Journal, Royal Economic Society, vol. 112(483), pages 532-565, November.
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