Working Paper: CEPR ID: DP8933
Authors: Hans Gersbach; Volker Hahn
Abstract: We introduce a new type of incentive contract for central bankers: inflation forecast contracts, which make central bankers? remunerations contingent on the precision of their inflation forecasts. We show that such contracts enable central bankers to influence inflation expectations more effectively, thus facilitating more successful stabilization of current inflation. Inflation forecast contracts improve the accuracy of inflation forecasts, but have adverse consequences for output. On balance, paying central bankers according to their forecasting performance improves welfare. Optimal inflation forecast contracts stipulate high rewards for accurate forecasts.
Keywords: Central banks; Incentive contracts; Inflation forecast targeting; Inflation targeting; Intermediate targets; Transparency
JEL Codes: E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inflation forecast contracts (E31) | stabilization of inflation (E63) |
| inflation forecast contracts (E31) | accuracy of inflation forecasts (E31) |
| accuracy of inflation forecasts (E31) | output variance (C29) |
| inflation forecast contracts (E31) | output variance (C29) |
| inflation expectations (E31) | inflation forecasts (E31) |
| costs of deviations from previous forecasts (C53) | inflation expectations (E31) |