Working Paper: CEPR ID: DP1969
Authors: Berthold Herrendorf; Manfred J. M. Neumann
Abstract: 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.
Keywords: central bank; central bank independence; median voter; partisan business cycle; representative democracy
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Political cycles (E32) | inflation stability (E31) |
| Majority control of the central bank (E58) | average inflation can be zero (E31) |
| Labor market distortions (J48) | preferences for central bank independence (E58) |
| Central bank independence (E58) | lower average inflation (E31) |
| Central bank independence (E58) | lower inflation variability (E31) |
| Central bank independence (E58) | uncorrelated with employment variability (J69) |