Research Discussion Papers, Bank of Finland
No 2/1999:
Accountability of the ECB and a Government's Incentives to Rebel against the Common Monetary Policy in EMU
Olli Castrén
Abstract: This paper considers how the "true" common monetary policy
that is conducted by the ECB under various sources of uncertainty will
differ from the policy that was agreed in the Maastricht Treaty, and how
the uncertainties may induce a representative government to criticise the
common monetary policy. Acquiring information about the transmission
mechanism, and revealing that information as well as information about the
ECB reaction function, is incentive compatible for the ECB both directly
and indirectly. The direct effect means that the ECB's own welfare is
decreasing in uncertainties. The indirect effect arises because less
uncertainty reduces the risk of criticism from the individual governments'
side. The risk of criticism is the larger, and consequently the indirect
incentive to reduce uncertainty is the higher, the larger are the leftward
shifts in national political preferences from those that prevailed when the
Maastricht Treaty was signed. The model also provides an explanation for
the ECB's choice of monetary policy strategy that incorporates elements of
both monetary targeting and inflation targeting.
Keywords: monetary uncertainty; monetary strategy; EMU; (follow links to similar papers)
JEL-Codes: E52; E58; (follow links to similar papers)
23 pages, February 19, 1999
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