On the Sources of the Inflation Bias and Output Variability

23 Pages Posted: 4 Feb 2005

Date Written: December 2004

Abstract

Why do dynamic inconsistencies in monetary policy exist? In this paper a traditional model without put inefficiencies is introduced, but monetary policy is allowed to be influenced by the various constituencies in the economy, that pressure Congress in turn to pressure the central bank to adopt a particular policy stance. The paper shows that in this economy an inflation bias arises due to the lobbying pressures of outsiders. Furthermore, it shows that if lobbying pressures are high enough, an inflation bias cannot be avoided for any finite level of central bank independence. It also shows 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 non myopic trade union which has no lobbying costs. This is independent of any finite degree of conservativeness of the central banker, who has to accept an extreme increase in price instability. It is shown 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 Inflation Bias and Output Variability (December 2004). Available at SSRN: https://ssrn.com/abstract=661164 or http://dx.doi.org/10.2139/ssrn.661164

Gustavo Piga (Contact Author)

University of Rome ( email )

Via di Tor Vergata
Rome, Lazio
Italy

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