DP3923 Delegation of Monetary Policy: More than a Relocation of the Time-Inconsistency Problem

Author(s): John Driffill, Zeno Rotondi
Publication Date: June 2003
Keyword(s): credibility, delegation, independent central banks, monetary policy, time-inconsistency
JEL(s): E31, E58, E61
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3923

It has been argued 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. We argue here that this is not so, and that delegation enables a wider class of economies to sustain zero inflation than would be able to do so in its absence. We consider an economy in which the government faces re-appointment costs, that is, costs associated with sacking one central banker and replacing them with another, costs which are intended to protect central bank independence. We show that, by means of suitable announcements of incentive schemes for the central bank, combined with appropriate actually implemented schemes, delegated policy enables zero inflation to prevail in economies in which it could not do so without delegated policy. These economies are ones that have relatively high discount rates (and so low discount factors).