The Reputation of a Newly Born Central Bank

Abstract

The effectiveness of monetary policy - i.e. its capacity to maintain a low rate of inflation without adverse effects on employment - crucially depends on the credibility of the Central Bank. According to Blinder (2000), this amounts to the reputation that has been earned through a consistent track record: "a history of matching words with actions". Therefore, almost by definition a newly born central bank will lack any credibility, unless.... Unless, it can inherit the reputation of a pre-existing central bank, like in the case of the ECB.

In this paper, we test the hypothesis - for which we find strong evidence - that not only in terms of institutional structure (and location: Frankfurt), but also in terms of the weights in its preference function, the ECB has so far closely resembled the Bundesbank. It is somewhat ironic that it has been the German economy which has not taken any benefit from that set up.

Keywords: Bundesbank, Central Bank, ECB, EMU, Interest Rate Rule, Lexicographic Preferences, Monetary Policy

JEL Classification: E42, E52, E58