DP1969 The Political Economy of Inflation, Labour Market Distortions and Central Bank Independence

Author(s): Berthold Herrendorf, Manfred J.M. Neumann
Publication Date: October 1998
Keyword(s): central bank board, Central Bank Independence, Median Voter, partisan business cycle, representative democracy
JEL(s): E52, E58
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1969

Using the citizen-candidate model, we relate the monetary policy objective to individuals' voting decisions and characterize equilibrium inflation and employment under central bank dependence and independence. We also endogenize the decisions about the labour market distortion and central bank independence. Our results are consistent with the fact that across OECD countries, independence is negatively correlated with average inflation and inflation variability and uncorrelated with employment variability. Moreover, we can explain why: (i) in several countries, central banks became independent while labour market distortions remained; (ii) notwithstanding McCallum's (1995) critique, delegation of monetary policy is effective; (iii) some independent central banks do not generate an inflation bias yet stabilize.