Central Bank Independence and Conservative Central Banking - PowerPoint PPT Presentation

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Central Bank Independence and Conservative Central Banking

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Title: Central Bank Independence and Conservative Central Banking Subject: Monetary economics Author: Kent Matthews Last modified by: plmlp Created Date – PowerPoint PPT presentation

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Title: Central Bank Independence and Conservative Central Banking


1
Lecture 9
  • Central Bank Independence and Conservative
    Central Banking

2
  • This lecture extends the analysis of reputation
    and credibility to the theory of central bank
    independence

3
Credibility building strategies
  • Credibility building measures include
  • 1) Joining and exchange rate mechanism- ERM?
  • 2) Consistent fiscal and monetary policy -
    stability pact?
  • 3) Independent Central Bank

4
Independent CB
  • This lecture will examine the third of these
    strategies
  • Staring point is a Rational Expectations Phillips
    curve where x is the deviation of output from
    equilibrium.
  • x (? - ?e) ?
  • where ? is inflation, ?e is the expected rate of
    inflation and ? is a random shock

5
Societys Iso-Loss function
6
?
C2
C1
C0
0
x-
x
7
Time-consistent policy is given by agents
optimising
8
But the CB/government optimises
9
The time-inconsistency problem
  • The last 2 equations highlight the
    time-inconsistency problem
  • the term bx- implies that the average inflation
    rate is above zero
  • The first best policy would be to eliminate the
    inflation bias without eliminating the degree of
    output stabilisation

10
But this is not credible
11
The Inflation Nutter Deflationary bias
?
?lt0
C3
A
?0
C2
?gt0
B
C1
C
C
x
A
B
12
Optimal set of preferences for a CB
13
Substitute CB preference result into societies
loss function
14
Optimising with respect to ?
15
Summary
  • Rogoff argues that ? lt b - we need a conservative
    CB but not too conservative
  • The model can be criticised - why should society
    prefer x- gt 0 when x 0?
  • Has to be argued in terms of distribution -
    political economy terms
  • Minford critique - society gets the CBs they
    deserve?

16
Evidence - Inflation?
17
Growth Variability
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