Essays on the political economy of central banking

Date of Completion

January 1999


Economics, Theory|Business Administration, Banking




This dissertation examines the delegation of monetary policy through optimal central banker contracts and the effects of central bank behavior on fiscal policy discipline in a monetary union. First, we examine whether central banker contracts are an optimal form of monetary policy delegation when incomplete information about the central banker's preferences exists. We show that optimal Walsh (1995) contracts do not eliminate the inflationary bias in monetary policy. We design a more comprehensive mechanism that achieves this task by inducing central bankers to reveal their preferences. This mechanism can work with the adoption of inflation targets or the appointment of conservative central bankers. We then consider the effectiveness of central banker contracts when more that one potential principal exists. We develop a common agency model in central banking and show that the government's (society's) contract does not always dominate the competing contract offered by a (private) interest group. Which of the two incentive schemes dominates depends on the goals of the contracts and the principals' relative concerns about contract costs. Finally, we develop a model of central bank decision making in a monetary union and examine how central bank behavior can enhance discipline for the national fiscal authorities. We show that introducing the possibility of tough punishment schemes enhances fiscal policy discipline by allowing the union central bank to reveal its type. ^