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A non-Normative Theory of Inflation and Central Bank Independence

  • Herrendorf, B.
  • Neumann, M.J.M.

We study monetary policy under different central bank constitutions when the labor-market insiders set the nominal wage so that outsiders are involuntarily unemployed. If the insiders are in the majority, the representative insider will be the median voter. We show that an independent central bank, if controlled by the median voter, does not produce a systematic inflation bias, albeit equilibrium employment is too low from a social welfare point of view. A dependent central bank, in contrast, is forced by the government to collect seigniorage and to take the government's re-election prospects into account. The predictions of our theory are consistent with the evidence that central bank independence decreases average inflation and inflation variability, but does not affect employment variability.

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File URL: http://www2.warwick.ac.uk/fac/soc/economics/research/workingpapers/2008/paper.pdf
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Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 515.

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Length: 20 pages
Date of creation: 1998
Date of revision:
Handle: RePEc:wrk:warwec:515
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Web page: http://www2.warwick.ac.uk/fac/soc/economics/

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