Equilibrium Contracts for the Central Bank of a Monetary Union

Abstract

We consider the political economy of a monetary union where member governments attempt to influence the policy of the common central bank. Modeling this as a common agency with incentive contracts, we show that if incentives are all that matters for the bank, the equilibrium implements a weighted average of the countries' most preferred policy. We then argue that making the bank inflation averse and/or attentive towards the countries' economic developments is undesirable in this context.

Keywords: Monetary Union, Incentive Contracts, Common Agency

JEL Classification: E52, E58, F33, F42