Working Paper: CEPR ID: DP1386
Authors: Berthold Herrendorf; Ben Lockwood
Abstract: This paper shows that delegation of monetary policy to a weight-conservative central banker is optimal, although the government can also use an inflation contract, an employment target, an inflation target, or any combination of these, to control the central banker. The key feature of our model is a stochastic inflation bias, arising when wage-setters receive some information about a supply shock prior to signing nominal wage contracts. Weight-conservatism is shown to be desirable if the stochastic inflation bias cannot be eliminated by optimal choice of the delegation parameters.
Keywords: conservative central banker; delegation; incomplete information
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Delegating monetary policy to a weight-conservative central banker (E58) | mitigates stochastic inflation bias (C54) |
| Non-state-contingent delegation (H77) | necessitates weight conservatism to manage inflation bias (E31) |
| Weight conservatism (E21) | lower inflation bias (E31) |
| Weight conservatism (E21) | reduced stabilization of the real economy (E63) |
| Delegation decision cannot be made state-contingent (D79) | tradeoff between credibility and stabilization of the real economy (E44) |
| Wage setters have information about supply shocks prior to wage setting (D83) | stochastic inflation bias occurs (E31) |