Working Paper: CEPR ID: DP4247
Authors: John Driffill; Zeno Rotondi
Abstract: In this Paper we argue that the objectives given to the European Central Bank in the Maastricht Treaty are not well represented by the widely used weighted sum of squared deviations of inflation and output from target (plus possibly terms in squared changes in interest rates to pick up interest rate smoothing). Instead the stated lexicographic ordering should be taken at face value and its implications explored fully. We set out a number of models that do this, and comment on their implications.
Keywords: European Central Bank; Lexicographic Preferences; Monetary Policy; Time Inconsistency
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ECB's lexicographic preference ordering (E58) | prioritizes price stability over output stability (E64) |
| prioritizing price stability (E64) | limits degrees of freedom for output stabilization (C69) |
| strict definition of price stability (E31) | constrains ECB's ability to respond to output shocks (E58) |
| lexicographic ordering (C69) | enhances accountability of central bankers (E58) |
| lexicographic ordering (C69) | clarifies relative importance of objectives (L21) |
| clarifying objectives (L21) | reduces uncertainty about weights attached to goals (D80) |
| framework (Y20) | allows for output smoothing while adhering to price stability (E31) |
| framework (Y20) | leads to better outcomes in inflation and unemployment (E31) |
| lexicographic preferences (D11) | facilitate better economic outcomes (F69) |