Research Papers in Economics, Department of Economics, Stockholm University
Optimal Inflation Targets, Inflation Contracts and Political Cycles
Abstract: It has been widely accepted that politically induced
variance can be generated when the wage contract is written before an
election. In this paper, we show that inflation contracts and inflation
targets can eliminate both the inflation bias and politically induced
variance, if electoral uncertainty is merely due to different preferences.
In contrast to the independent central bank that is based on cooperation
between competing parties prior to the target can be delegated by the
winning party after election. Concern for reputation can lead to the
convergence of the inflation targets assigned by different parties. We also
consider the case where uncertsinty is caused not only by different
preferences, but also by different desired rates inflation. We show that it
is quite possible to reduce inflation but increase the variances of
inflation and output by adopting the inflation target regime.
Keywords: central bank independence; inflation contract; inflation target; and electoral uncertainty.; (follow links to similar papers)
JEL-Codes: A10; (follow links to similar papers)
28 pages, April 1, 1998
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