The Macroeconomic Effects of External Pressures on Monetary Policy
42 Pages Posted: 13 Aug 2008
Date Written: July 13, 2007
Central banks, whether independent or not, may occasionally be subject to external pressures to change policy objectives. We analyze the optimal response of central banks to such pressures and the resulting macroeconomic consequences. We consider several alternative scenarios regarding policy objectives, the degree of commitment and the timing of external pressures. The possibility to adopt "more liberal" objectives in the future increases current inflation through an accommodation effect. Simultaneously, the central bank tries to anchor inflation by promising to be even "more conservative" in the future. The immediate effect is an output contraction, the opposite of what the pressures to adopt "more liberal" objectives may be aiming. We also discuss the opposite case, where objectives may become "more conservative" in the future, which may be the relevant case for countries considering the adoption of inflation targeting.
Keywords: Monetary Policy, Time-Consistency, Political Disagreement
JEL Classification: E52, E58, E61
Suggested Citation: Suggested Citation