Introductory remarks

Transcription

1 Introductory remarks The Barro and Gordon model provides a framework for analyzing time-inconsistency problems in monetary policy Demonstrates that credibility problems have economic costs In the particular model, an in ation bias In other elds: Speculative attacks on non-credible exchange rate pegs Hyperin ations if governments cannot credibly refrain from in ationary nance Disin ations typically have signi cant output costs Suboptimal savings and investments, if governments cannot credible refrain from impose surprise taxes on wealth A market mechanism based on reputation building and evolution of social norms, can be one way of attaining credibility If not viable, other mechanisms may be necessary => Normative theories of how to overcome time-inconsistency problems by altering the central bank s incentives c 2011 Henrik Jensen. This document may be reproduced for educational and research purposes, as long as the copies contain this notice and are retained for personal use or distributed free.

2 Delegation and independent central banks The incentive to surprise in ation is often interpreted as arising from political pressures Solution to time-inconsistency problem could be achieved by Delegating monetary policy conduct to independent central banks => Create monetary institutions securing independence and appropriate policy incentives I.e., appropriate design of policy regime in broadest sense Several solutions proposed in the literature Analyses here are cast in versions of Barro Gordon model with Variant II utility, I.e., U = 2 (y y n k) and with usual AS schedule: y = y n + a ( e ) + e; E [e] = 0 In ation is the policy instrument. Remember, the socially optimal, ex ante, policy: = b 0 b 1 e = a 1 + a 2e 2

3 Under delegation, a new stage in the move structure; the institutional design stage : 1: Establishment of monetary delegation regime 2: e is formed 3: e is realized 4: is set 5: y is determined Delegation to a conservative central banker The idea is to appoint a central banker, who puts relative more weight on in ation stabilization than society I.e., monetary policy is delegated to central banker with utility U c = 2 (y y n k) ; > 0 This is Rogo s conservative central banker; measures the degree of conservativeness (Rogo, 1985, QJE) Monetary policymaking by the central banker (taking as given e and e) is characterized by the rst-order condition a (a ( e ) + e k) = (1 + ) (*) Note that > 0 increases the marginal cost of in ation Rational in ation expectations follow by taking expectations on both sides of (*): ak = (1 + ) E [] =) E [] = ak 1 + < ak 3

4 With a conservative central banker, the in ation bias is reduced from ak to ak= (1 + ) the private sector foresees the central banker s reduced incentive to increase in ation to achieve output gains Conservativeness, however, has a cost. The solution for actual in ation becomes (plug the solution for e =E[] back into (*)) = ak 1 + Stabilization of the shock is distorted a a2e (7.18 ) Compared to the socially optimal response to a supply shock, a conservative central bank responds less to the shock Result is too stable in ation and too unstable output Appointing a conservative central bank thus involves a trade-o between a) Lower average in ation b) Poorer macroeconomic stabilization So, will it ever be optimal to have > 0? Yes, always: At = 0, a marginal increase in involves a rst-order social gain of lower average in ation (at = 0 average in ation is suboptimal) At = 0, a marginal increase in involves a second-order social loss of poorer stabilization (at = 0 stabilization is optimal) 4

5 The conservative central banker appointing a governor with particular preferences thus partially solves the time-inconsistency problem of monetary policymaking The cost of poorer stabilization, however, begs the question of whether other preferences, or incentive structures, may solve the problem completely This is the question asked in the incentive contracts approach to delegation Incentive contracts Under this approach, the government appoints a central bank, and o ers him/her a performance contract This contract rewards or punishes the central bank depending on its performance The contract could be pecuniary but more generally, it could represent public embarrassment if the central bank doesn t ful ll its contract Real world analogy: The Federal Reserve Act of 1989 in New Zealand: The governor can be red, if he performs poorly... 5

6 Formally, the central bank is o ered a contract, such that it maximizes U + t where t is the contract transfer Assume that the contract transfer cannot be made contingent on the supply shock, so only a transfer depending on observed in ation is considered: t = t () Task of government is to choose the optimal t () (at institutional design stage) Central bank takes expectations and the supply shock as given, and maximizes 2 (a ( e ) + e k) t () The rst-order condition is a (a ( e ) + e k) = t 0 () (**) If t 0 () < 0 we see that the marginal cost of in ation is higher than without the transfer; i.e., the contract punishes in ation increases Rational in ation expectations follow by taking expectations on both sides of (**): ak = E [] E [t 0 ()] =) E [] = ak + E [t 0 ()] 6

7 Insert these expectations back into (**) to get actual in ation a (a ( ak E [t 0 ()]) + e k) = t 0 () = ak + a2 1 + a 2E [t0 ()] + t0 () a 1 + a a 2e Optimal policy is implemented if the transfer function satis es ak + a2 1 + a 2E [t0 ()] + t0 () 1 + a = 0 2 This is accomplished if t 0 () = ak A transfer function with this property: t () = t 0 ak A linear in ation contract Linear because the incentive to surprise the private sector is a constant in equilibrium; hence, a constant marginal punishment eliminates the in ation bias (also for non-quadratic utility) In contrast to a conservative central banker, the linear in ation contract portrays the optimal incentive structure, implementing optimal average in ation and optimal shock stabilization 7

8 Under the optimal contract, the central bank retains exibility to respond optimally towards shocks Often monetary institutions, however, are set up to limit this exibility in order to reduce, e.g., the central bank s vulnerability towards political pressures This is often modelled as targeting rules prescribing goals that the central bank should achieve through policy I.e., the central bank is judged on its ability to attain these goals (note analogy with contract approach...) Examples are exchange rate targeting, in ation targeting, money supply targeting,... 8