Independence of the Central Bank, Growth and Coalitions in a Monetary Union

Abstract

Within a Monetary Union, we assume that the policy of a hard-nosed central bank results in a real appreciation of the Union currency, which is in contradiction with the growth targets of several countries. These countries may join together to question the policy of the bank. As a consequence, the bank itself will try to form an alliance with other countries to prevent decisions that would be opposed to its goals. This makes it deviate from its primary monetary target. There is thus a game involving the formation of coalitions between the Union countries and the Central bank so as to determine the Union's monetary policy. We show that this game results, either in the formation of a unique stable coalition between the Bank and certain countries, or in a total independence of the Bank. The induced monetary policy depends on the majority required to modify the policy of the bank. Moreover, when a unanimous decision is necessary to question the bank's decision, the game prompts the worst possible solution for half of the Union countries.

Keywords: Central Bank Independence, Growth, Monetary Union

JEL Classification: E58, F15, F33, F43