Scandinavian Working Papers in Economics

Working Paper Series,
Uppsala University, Department of Economics

No 2008:15: Delegation, Time Inconsistency and Sustainable Equilibrium

Henrique S Basso ()
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Henrique S Basso: Department of Economics, Postal: Uppsala University, P.O. Box 513, SE-751 20 Uppsala, Sweden

Abstract: This paper analyzes the effectiveness of delegation in solving the time inconsistency problem of monetary policy using a microfounded general equilibrium model where delegation and reappointment are explicitly included into the government's strategy. The method of Chari and Kehoe (1990) is applied to characterize the entire set of sustainable outcomes. Countering McCallum's (1995) second fallacy, delegation is able to eliminate the time inconsistency problem, with the commitment policy being sustained under discretion for any intertemporal discount rate.

Keywords: Central Bank; Monetary Policy; Institutional Design

JEL-codes: E52; E58; E61

26 pages, October 31, 2008

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