Central Bank Independence and the `Free Lunch Puzzle': A New Perspective
A new perspective is provided on a puzzle that has emerged from the empirical lit- erature suggesting that government-independent central banks provide a `free lunch': lower in°ation is apparently achieved at no cost in terms of greater output variance. We assess the various explanations provided by the theoretical literature. After revis- iting the free lunch puzzle and con¯rming the empirical importance of open-economy effects, we develop a Rogoff-style delegation model that combines the latter with po- litical monetary cycle e®ects. We show that if all countries delegate monetary policy to government independent banks, as economies become more integrated then a low inflation, higher output variance trade-off re-emerges.
|Date of creation:||Mar 2006|
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