Delegation Of Monetary Policy Research Articles

Optimal monetary policy delegation in a small-open new Keynesian model with robust control

Optimal monetary policy delegation in a small-open new Keynesian model with robust control

Central bank independence in Latin America: Politicization and de‐delegation

AbstractIn the last three decades, legal delegation of monetary policy to independent central banks (CBI) has achieved the status of a global norm of good governance. The recent backlash against this independence is an important but understudied trend. Our article analyzes the potential for delegation reversals with a focus on Latin America where CBI was effective in maintaining price stability, but placed important policy constraints on governments. We theorize that, in the shadow of the global norm for CBI, the increasing distance in preferences between the government and the central bank, and the procedural hurdles to change the status quo, explain the intensity of challenges to the delegation contract or the delegated agent. An analysis of the frequency of irregular central bank leadership replacements, and instances of politicization and de‐delegation show the plausibility of our argument. We also show that, in Latin America, reforms de‐delegating monetary policy have been small, balancing the needs that justified delegation in the first place, but rolling back the most stringent constraints placed on financing the government.

Political economy behind central bank independence

This paper proposes a model that analyzes the reasons behind the establishment and persistence of central bank independence (CBI) in a competitive democracy where both incumbent and opposition parties have the right to veto the delegation of monetary policy. We show that in a country with a high level of corruption, the opposition party uses the absence of CBI to keep the economy unstable to increase its own chances of getting elected. The model also predicts persistence of CBI once it is established, due to the incumbent’s fear of losing the office if the autonomy is removed.

Nominal targeting in an economy with government debt

The fiscal policy environment central banks operate in can be radically different with respect to debt levels, maturity structures and whether or not fiscal adjustments are spending- or tax-based. Despite this, most analyses of monetary policy delegation schemes typically ignore the behavior of the fiscal policy maker. This paper investigates whether delegating either nominal income or price level targets to a monetary authority yields social gains in an economy with government debt, where the fiscal policymaker, acting strategically, may support or undermine the policies of the central bank. We argue that the fiscal environment plays an important role in determining the performance of monetary policy. The gains to price level targeting typically found in the literature can be overturned at empirically relevant debt-to-GDP ratios, when debt stabilization is achieved through spending cuts. In contrast these gains are retained if the fiscal authorities utilize taxes to respond to shocks and stabilize debt.

Nominal Targeting in an Economy with Government Debt

The fiscal policy environment central banks operate in can be radically different with respect to debt levels, maturity structures and whether or not fiscal adjustments are spending or tax based. Despite this, most analyses of monetary policy delegation schemes typically ignore the behavior of the fiscal policy maker. The paper investigates how monetary price level targeting or monetary nominal income targeting may yield social gains in an economy with government debt and where the fiscal policymaker, acting strategically, may support or undermine the policies of the central bank. We argue that the level of debt, its maturity and choice of fiscal policy instrument play an important role in determining the performance of monetary policy. The gains to price level targeting typically found in the literature can be overturned at empirically relevant debt to GDP ratios, when debt stabilization is achieved through spending cuts. In contrast these gains are retained if the fiscal authorities raise taxes to stabilize debt.

An Empirical Assessment of Optimal Monetary Policy Delegation in the Euro Area

We estimate a New Keynesian DSGE model for the Euro area under alternative descriptions of monetary policy (discretion, commitment or a simple rule) after allowing for Markov switching in policy maker preferences and shock volatilities. This reveals that there have been several changes in Euro area policy making, with a strengthening of the anti-inflation stance in the early years of the ERM, which was then lost around the time of German reunification and only recovered following the turnoil in the ERM in 1992. The ECB does not appear to have been as conservative as aggregate Euro-area policy was under Bundesbank leadership, and its response to the financial crisis has been muted. The estimates also suggest that the most appropriate description of policy is that of discretion, with no evidence of commitment in the Euro-area. As a result although both ‘good luck’ and ‘good policy’ played a role in the moderation of inflation and output volatility in the Euro-area, the welfare gains would have been substantially higher had policy makers been able to commit. We consider a range of delegation schemes as devices to improve upon the discretionary outcome, and conclude that price level targeting would have achieved welfare levels close to those attained under commitment, even after accounting for the existence of the Zero Lower Bound on nominal interest rates.

Monetary and fiscal institutional designs

Two investment decisions in economic institutions are feasible; investments in monetary institutions in the form of delegation of monetary policy to a more conservative or independent central bank, and investments in fiscal capacity, in the form of combating bureaucratic corruption and its consequent fiscal revenue leakages. Within this framework, we investigate the interactions among those two institutional decisions and the obtained institutional structure. The findings provide support of strategic complementarities; investments in monetary and fiscal institutions reinforce each other. In addition, we identify a set of determinants that impact on the government’s decisions to improve economic institutions, particularly, the structure and intensity of the initial corruption level, the amount of distortions caused by taxation and the policymaker’s goals and preferences across its objectives.

Discretionary Fiscal Policy in the EMU Context: An Empirical Approach (1981-2010) & the Recent Reform in European Governance

1. Introduction The debt crisis in the Eurozone (EZ) is one of the most crucial challenges in modern economic history. The decline of public finances of many member states constitutes an explosive mixture that threatens the existence of the Eurozone itself and has significant impacts for the global economy. As the leadership of EU is still searching for solutions and actions which will counteract the problem and restore the stability, the analysis of the causes which led to the systemic crisis, the examination of the institutional framework of European governance and the evaluation of the measures and policies adopted, are considered as matters of great importance which require extensive analysis and critical approach. The current paper attempts to approach these aspects from the perspective of fiscal policy, examining them from both a theoretical and empirical background. Membership in the Eurozone implies that apart from the delegation of monetary policy to the conservative European Central Bank (ECB), there are obligations and restrictions on fiscal policy for the member states. Even though the latter remains a political tool into the hands of national authorities, they must comply with the rules set at EU level in order the stability to be achieved. The implementation of sound and disciplined fiscal policies and the coordination of them in central level are key elements for ensuring the financial stability in the eurosystem. As the project of European integration was not associated with a fiscal union, the member states have maintained the independence of their national fiscal policies. However, their autonomy is limited significantly by the existence of the euro zone's supranational fiscal rule. The Stability and Growth Pact (SGP) offers guidance and coordinates the implementation of fiscal policy through the obligation of member states to respect the rules and the procedures that the Pact predicts. The target of the SGP is to perform effectively a dual function: to ensure the sustainability of public finances prompting the governments to run sound policies and to provide the necessary flexibility so as the national authorities to be able to deal with the negative fluctuations of the business cycle. This paper consists of two parts. In the first section, we are trying to acknowledge the particular structure of fiscal policy in EMU context. We examine empirically how the restrictions of Maastricht criteria and the SGP have impaired the capacity of national authorities to run countercyclical discretionary fiscal policies and whether the stabilization function of fiscal policy is associated with less procyclical discretionary policies. The division of the EZ countries into two subgroups (north--south) will provide us useful conclusions about the different effects the constraints have had on rich north and poor south. Lastly, we will evaluate whether the national fiscal rules can counteract political indiscipline and their efficiency on budget outcomes. In the second section, we will approach the recent reform of the European governance, providing details of the reform package and discussing its appropriateness and its potential effectiveness on the restore of the European financial stability. 2. Discretionary Fiscal Policy in the EMU: An Empirical Approach The main objective of the empirical analysis is to examine to what extent the constraints of both Maastricht criteria and SGP have affected the way national authorities conduct their discretionary fiscal policy. Provided that the monetary policy of all countries in the Eurozone is managed by the ECB, the fiscal policy undertakes the responsibility to operate as a stabilizing tool of the business cycle and to counteract the negative asymmetric shocks. Consequently, it is the foremost tool in the quiver of governments to deal with their country-specific fluctuations. For this reason, we would expect that the process of European integration should be linked to the adoption by the member-states of more countercyclical discretionary fiscal policies. …

Monetary Policy Delegation and Transparency of Policy Targets: A Positive Analysis

AbstractWe show that, in a two-stage model of monetary policy with stochastic policy targets and asymmetric information, the transparency regime chosen by the central bank does never coincide with the regime preferred by society. Independent of society’s endogenous choice of delegation, the central bank reveals its inflation target and conceals its output target. In contrast, society would prefer either transparency or opacity of both targets. As a conclusion, the choice of the transparency regime should be part of the optimal delegation solution.

Comparing the Delegation of Monetary and Fiscal Policy

The apparent success of independent central banks in conducting monetary policy has led many to argue that some form of policy delegation should also be applied to the macroeconomic aspects of fiscal policy. A number of countries have recently established Fiscal Councils, although their role is typically to give advice on paths for government debt and deficits rather than decide upon and implement policy. This paper examines how useful a comparison between monetary and fiscal policy can be in motivating and guiding Fiscal Councils. Simple analogies between inflation bias and deficit bias can be misleading, and the motives for delegating aspects of fiscal policy may be rather different from those generally associated with monetary policy. In addition, lack of knowledge about the desirable goals of long run debt policy, compared to a greater understanding of the objectives of monetary policy, may help explain key differences in the nature of delegation between the two. The paper ends by making some comparisons between the delegation of monetary and fiscal policy in the United Kingdom.

Transaction-cost efficiency and the democratic deficit

The extensive literature on the European Union's (EU) democratic deficit suffers from two serious limitations. First, it proposes to solve the problem by analogy with national practices instead of looking for its roots, and possible solutions, in the integration process itself. Second, this literature considers only the normative aspects of a condition that also has significant efficiency implications. Analogical reasoning has led to a continuous expansion of the powers of the European Parliament (EP) without any notable increase in democratic legitimacy. The origin of the democratic deficit is, quite simply, the failure to convert a majority of voters to the cause of political integration. This failure forced integrationist elites to sacrifice democracy on the altar of deeper integration in the hope of ‘making Europe without Europeans’. The strategy of pursuing political integration under the guise of economic integration backfired when it became evident that the EU kept falling behind its major international competitors in spite of ambitious projects like the Single European Market and Economic Monetary Union (EMU). One reason for this unsatisfactory performance is that in sacrificing democracy for the sake of deeper integration, EU leaders also sacrificed many formal and informal methods developed by democratic regimes in order to reduce various political transaction costs. Thus delegation of monetary policy to an independent central bank is a well-known method for solving the time inconsistency problem. In case of serious external shocks, however, a balance must be struck between commitment to monetary stability and flexibility. This is possible in a democracy, where elected policy-makers are able to provide the necessary political counterweight to the central bank's technocrats; this is impossible in the EU, where the European Central Bank (ECB) operates in a political vacuum. In turn, exclusive commitment to monetary stability further undermines the legitimacy of the Union. At present it seems that the only feasible way of reducing the democratic deficit is to reduce the mismatch between the extensive commitments of the EU and its limited normative and institutional resources.

Dancing Together at Arm’s Length? The Interaction of Central Banks with Governments in the G7

Central bank independence is a common feature in advanced economies. Delegation of monetary policy to an independent central bank with a clear mandate for price stability has proven to be successful in keeping a check on inflation and providing a trusted currency. However, it is also a fact that central banks in most countries have regular contacts with the government and cooperate with them on a number of issues. This paper looks into the various forms of cooperation between central banks and governments in the G7. The focus is on those central banks that exercise a monetary policy decision-making function, i.e. the ECB and the central banks of the four G7 countries outside the euro area (the US, UK, Japan and Canada). The paper first reviews the objectives of and arrangements for central bank/government cooperation in the US, UK, Japan and Canada in areas such as monetary policy and its interlink with economic policy; foreign exchange operations and foreign reserve management; international cooperation; payment systems/securities learing and settlement systems; upervision, regulation and financial stability; banknotes and coins; collection of statistics; and the role of fiscal agent for the government. In parallel the paper looks into the objectives of and arrangements for cooperation between the ECB and relevant European counterparts, reflecting the specific European institutional environment characterised by the absence of a ‘European government’. Following a comprehensive stocktaking of practices, the paper embarks on a comparison of existing arrangements, pointing to the similarities and differences among the five surveyed central banks. The Appendix provides a more in-depth description of central bank/government cooperation per country and topic; it presents the detailed factual background on which the paper builds, serving as a reference for the reader interested in more detail. JEL Classification: D83, C62, E30

Does Model Uncertainty Justify Conservatism? Robustness and the Delegation of Monetary Policy

This paper analyzes the rationale for delegating monetary policy to an inflation-averse central banker when there is a preference for robustness of optimal policy with respect to misspecifications of the underlying model of the economy. We use a simple New Keynesian model to show how the optimal output gap weight in the central bank's objective function depends on the degree of model uncertainty. In particular, we show numerically that the rationale for appointing a conservative central bank prevails even if the central bank is concerned about the robustness of policy with respect to model misspecifications. Moreover, we find that the central bank should put more relative weight on inflation stabilization if the degree of uncertainty increases. Interestingly, if the degree of uncertainty is large, monetary policy should be delegated to a conservative central banker even in the absence of shock persistence.

The stabilization bias and robust monetary policy delegation

Discretionary monetary policy suffers from a stabilization bias, whose size is known to be dependent on the degree of shock persistence. This note analyzes the size of this bias and, consequently, the rationale for delegating monetary policy to an inflation-averse central banker, when the economy faces uncertainty about the true degree of shock persistence. We show that the stabilization bias increases if uncertainty becomes larger. Hence, the degree of optimal monetary conservatism increases with the degree of uncertainty.

Central bank reputation in a forward-looking model

This paper examines whether reputation concerns can induce the central bank to implement the time-inconsistent optimal monetary policy in the standard New Keynesian model. Interestingly, the forward-looking nature of this model enables us to account for the coordination of the private agents on the punishment length of their trigger strategy. Our results suggest that both the inflation bias and the stabilization bias can be overcome by a reputation-concerned central bank for the calibrations used in the literature. These results enable us to endogenize Woodford's timeless perspective and tend to weaken the case for recent monetary policy delegation proposals.

Central Bank Reputation in a Forward-Looking Model

This paper examines whether reputation concerns can induce the central bank to implement the time-inconsistent optimal monetary policy in a standard New Keynesian model. The forward-looking nature of this model is in this respect interesting on two accounts: first, it worsens the time-inconsistency problem of optimal monetary policy by adding a stabilization bias to the possible inflation bias; second, it enables us to model more satisfactorily the reputation of the central bank by accounting for the coordination of the private agents on the punishment length. Our results suggest that the inflation bias and the stabilization bias can be overcome for the calibrations used in the literature. These results enable us to endogenize Woodford's timeless perspective and weaken the case for monetary policy delegation.

Model Uncertainty and Delegation: A Case for Friedman's k‐Percent Money Growth Rule?

Model uncertainty affects the monetary policy delegation problem. If there is uncertainty with regards to the determination of the delegated objective variables, the central bank will want robustness against potential model misspecifications. We show that with plausible degree of model uncertainty, delegation of the Friedman rule of increasing the money stock by k percent to the central bank will outperform commitment to the social loss function (flexible inflation targeting). The reason is that the price paid for robustness under flexible inflation targeting outweighs the inefficiency of money growth targeting. Imperfect control of money growth does not change this conclusion.

Credibility of Optimal Monetary Delegation: Comment

In his recent paper in the American Economic Review, Jensen (1997) argues that delegation of monetary policy to an independent central bank, which acts as an agent for the government, does not mitigate the problem of time-inconsistency, but merely relocates it.

Strategic wage setting, inflation uncertainty and optimal delegation

The paper examines optimal monetary policy delegation in an economy where wages are set strategically by a single economy-wide union whose objectives relate to employment and the real wage. Crucially, the central bank exerts imprecise control over inflation, giving rise to a positive relationship between the mean value of inflation and its variance. In this context, union concerns with regard to the employment goal render equilibrium sensitive to the conduct of monetary policy. As a consequence, optimal delegation arrangements closely resemble those identified as optimal in models that assume a direct aversion to inflation on the part of unions.

Inflation, government transfers, and optimal central bank independence

The problem of monetary policy delegation is formulated as a two-stage non-cooperative game between the government and the central bank. The solution to this policy game determines the optimal combination of central bank conservatism and independence. The results show that the optimal institutional design always requires some degree of central bank independence and that there is substitutability between central bank independence and conservatism. The results also show that partial central bank independence can be optimal and that there are circumstances under which it is optimal for the government to appoint a liberal central banker.