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Central bank independence and the monetary instrument problem

Niemann, S and Pichler, P and Sorger, G (2010) Central bank independence and the monetary instrument problem. UNSPECIFIED. University of Essex, Department of Economics, Economics Discussion Papers 687.

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Abstract

We study the monetary instrument problem in a model of optimal discretionary fiscal and monetary policy. The policy problem is cast as a dynamic game between the central bank, the fiscal authority, and the private sector. We show that, as long as there is a conflict of interest between the two policy-makers, the central bank's monetary instrument choice critically affects the Markov-perfect Nash equilibrium of this game. Focusing on a scenario where the fiscal authority is impatient relative to the monetary authority, we show that the equilibrium allocation is typically characterized by a public spending bias if the central bank uses the nominal money supply as its instrument. If it uses instead the nominal interest rate, the central bank can prevent distortions due to fiscal impatience and implement the same equilibrium allocation that would obtain under cooperation of two benevolent policy authorities. Despite this property, the welfare-maximizing choice of instrument depends on the economic environment under consideration. In particular, the money growth instrument is to be preferred whenever fiscal impatience has positive welfare effects, which is easily possible under lack of commitment.

Item Type: Monograph (UNSPECIFIED)
Subjects: H Social Sciences > HB Economic Theory
Divisions: Faculty of Social Sciences > Economics, Department of
Depositing User: Jim Jamieson
Date Deposited: 17 Jul 2012 11:36
Last Modified: 17 Aug 2017 18:11
URI: http://repository.essex.ac.uk/id/eprint/2902

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