On the Sources of the Inflationary Bias

Columbia University Econ Dept Discussion Paper No. 9798-12

19 Pages Posted: 27 Dec 1998

Date Written: February 1998


Why do dynamic inconsistencies in monetary policy exist? In this paper we present a traditional model with output inefficiencies, but we allow for monetary policy to be influenced by the various constituencies in the economy, that pressure the Congress to in turn pressure the central bank to adopt a particular policy stance. We show that in this economy an inflationary-bias arises due to the lobbying pressures of outsiders. Furthermore, we show that if lobbying pressures are high enough, an inflationary-bias cannot be avoided for any finite level of central bank independence. We also show that introducing the realistic feature of lobbying pressures has an impact on the stabilization properties of monetary policy. When a supply shock occurs, the shock is totally absorbed by a forward-looking trade-union which has no costs of lobbying, independently of any finite degree of conservativeness and independence of the central banker, who has to accept an extreme increase in price instability. We show that monetary policy delegation is therefore sub-optimal in achieving price-stability compared to labor-market reforms meant to remove monopsonistic elements. However, the same structural policies will induce greater output instability by strengthening the power of conservative central bankers.

JEL Classification: E52, E58, E31

Suggested Citation

Piga, Gustavo, On the Sources of the Inflationary Bias (February 1998). Columbia University Econ Dept Discussion Paper No. 9798-12, Available at SSRN: https://ssrn.com/abstract=138250 or http://dx.doi.org/10.2139/ssrn.138250

Gustavo Piga (Contact Author)

University of Rome ( email )

Via di Tor Vergata
Rome, Lazio

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