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Optimal Contracts for Central Bankers and Inflation and Exchange Rate Targeting Regimes

  • Ronald A. Ratti

    (University of Missouri-Columbia)

This paper analyses the implications of adding a foreign exchange rate term to the loss function in the standard model for the issues of discretion and commitment in monetary policy. It is found that neither a linear state-contingent inflation contract for the central bank nor an explicit state-contingent inflation target (that implies a state- contingent foreign exchange rate target) combined with a weight- conservative central bank can now achieve the equilibrium matching that of an optimal rule under commitment. A linear state-contingent contract in a variable that is a weighted average of inflation in excess of target and of the rate of depreciation in the foreign exchange rate in excess of target is now required to mimic the optimal rule under commitment.

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Paper provided by EconWPA in its series Macroeconomics with number 9902001.

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Length: 26 pages
Date of creation: 04 Feb 1999
Date of revision:
Handle: RePEc:wpa:wuwpma:9902001
Note: 26 pages (title and abstract page, 25 numbered pages), WordPerfect 5.1
Contact details of provider: Web page: http://econwpa.repec.org

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  1. 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.
  2. 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.
  3. 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.
  4. David Romer, 1991. "Openness and Inflation: Theory and Evidence," NBER Working Papers 3936, National Bureau of Economic Research, Inc.
  5. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
  6. Alan S. Blinder, 1999. "Central Banking in Theory and Practice," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262522608, June.
  7. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  8. D. Backus & J. Driffil, 1998. "Inflation and Reputation," Levine's Working Paper Archive 625, David K. Levine.
  9. 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.
  10. Frankel, Jeffrey A., 1991. "The Stabilizing Properties of a Nominal GNP Rule in an Open Economy," Department of Economics, Working Paper Series qt7xz9d77c, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  11. Frankel, Jeffrey, 1995. "The Stabilizing Properties of a Nominal GNP Rule," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 27(2), pages 318-34, May.
  12. Fischer, Stanley, 1990. "Rules versus discretion in monetary policy," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 21, pages 1155-1184 Elsevier.
  13. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  14. Matthew B. Canzoneri, 1983. "Monetary policy games and the role of private information," International Finance Discussion Papers 249, Board of Governors of the Federal Reserve System (U.S.).
  15. Fischer, Stanley, 1995. "Central-Bank Independence Revisited," American Economic Review, American Economic Association, vol. 85(2), pages 201-06, May.
  16. Backus, David & Driffill, John, 1985. "Rational Expectations and Policy Credibility Following a Change in Regime," Review of Economic Studies, Wiley Blackwell, vol. 52(2), pages 211-21, April.
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