Abstract
This paper extends Cukierman’s (1992) model of monetary policy discretion, private information, and credibility to an environment in which the quantity of money is endogenous and in which a monetary authority must choose between bank reserves or an interest rate as its instrument of monetary policy. This model is used to explore the determinants of credibility for the alternative policy instruments and to evaluate the manner in which political pressures on a monetary authority can influence the authority’s instrument choice. A key implication of the model is that such political pressures can influence the credibility of monetary policy differentially depending upon the choice of policy instrument, thereby inducing a monetary authority to choose an instrument that otherwise would fail to meet standard Poole (1970) criteria. Keywords: Optimal monetary policy; Monetary policy instruments; Monetary politics JEL classification: E52; E58
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