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Published byEvan Joyce Modified over 11 years ago
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Lecture 9 Central Bank Independence and Conservative Central Banking
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This lecture extends the analysis of reputation and credibility to the theory of central bank independence
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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
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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
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Societys Iso-Loss function
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x 0 C0C0 C1C1 C2C2 x-x-
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Time-consistent policy is given by agents optimising
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But the CB/government optimises
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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
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But this is not credible
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The Inflation Nutter Deflationary bias x A B C C1C1 C2C2 C3C3 >0 =0 <0 C B A
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Optimal set of preferences for a CB
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Substitute CB preference result into societies loss function
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Optimising with respect to
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Summary Rogoff argues that < b - we need a conservative CB but not too conservative The model can be criticised - why should society prefer x - > 0 when x* = 0? Has to be argued in terms of distribution - political economy terms Minford critique - society gets the CBs they deserve?
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Evidence - Inflation?
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Growth Variability
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