Working Paper: CEPR ID: DP7482
Authors: Florin Ovidiu Bilbiie
Abstract: This paper shows that absent a commitment technology, central banks can nevertheless achieve the (timeless-)optimal commitment equilibrium if they are delegated with an objective function that is different from the societal one. In a prototypical forward-looking New Keynesian model, I develop a general linear-quadratic method to solve for the optimal delegation parameters that generate the optimal amount of inertia in a Markov-perfect equilibrium. I study the optimal design of some policy regimes that are nested within this framework: inflation, output-gap growth and nominal income growth targeting; and inflation and output-gap contracts. Notably, since the timeless-optimal equilibrium is time-consistent, so is any delegation scheme that implements it.
Keywords: inflation; output gap; growth; nominal income growth targeting; discretion and commitment; inertia; optimal delegation; stabilization bias; time inconsistency; timeless-optimal policy
JEL Codes: C61; C73; E31; E52; E61
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Delegating monetary policy objectives (E52) | achievement of optimal policy inertia (E61) |
| Central bank assigned a different objective function (E52) | ability to achieve timeless-optimal commitment equilibrium (D51) |
| Current inflation (E31) | future expected inflation (E31) |
| Delegated loss function incorporating lagged output gap (E23) | influence future expectations (D84) |
| Specific combinations of targeting regimes (F13) | restoration of optimality (C61) |
| Optimal delegation schemes (C78) | induce desired inertia in monetary policy (E63) |