There is a growing and politically influential literature suggesting that elected governments should delegate responsibility for the operation of monetary policy to politically independent central bankers who are more `conservative' in the sense that they assign a higher priority to low inflation than that of the representative government. If the banker is solely concerned with inflation, then zero inflation can be delivered, but at the expense of not responding to temporary shocks. The optimal choice of conservatism then depends on the short-run trade-off between the benefits of output stabilization and permanently low inflation. By playing this `delegation game', the government of a closed economy can achieve a superior outcome in terms of the social welfare function.

In Discussion Paper No. 1148, Joseph Pearlman and Research Fellows David Currie and Paul Levine provide a comprehensive assessment of the open economy aspects of the delegation game. In an n-country model, they examine and compare four possible structures or `regimes' for the conduct of monetary policy characterized in terms of the form (or absence) of precommitment. The regime they use to calibrate the model is a non-cooperative equilibrium with representative bankers or bankers under the control of government. When all countries optimally and independently choose the conservatism of their bankers, a highly inefficient Nash equilibrium can result. This inefficiency increases as the number of countries increases, the correlation of shocks increases, and if there is unemployment persistence. Delegation can be counterproductive in the sense that the non-cooperative equilibrium of the delegation game results in a lower welfare than that of the representative bankers game.

Can Delegation Be Counterproductive? The Choice of `Conservative' Bankers in Open Economies
David Currie, Paul Levine and Joseph Pearlman

Discussion Paper No. 1148, March 1995 (IM)