Central Bank Independence and the Design of Fiscal Institutions
38 Pages Posted: 14 Feb 2006
Date Written: December 2001
We study the desirability of reforming fiscal institutions along with the delegation of monetary policy to an independent central bank. The model provides a rationale for discipline-enhancing fiscal institutions and highlights some of their desirable features. Three main results emerge. First, when the government can pre-commit on fiscal strategies, fiscal discretion is optimal only if the central bank strictly targets the socially optimal inflation rate. Second, without pre-commitment technology, fiscal restraints are desirable and contingent on the strategic interaction between monetary and fiscal authorities. Third, deficit rules are generally inefficient, and instrument-specific rules based on a combination of linear and quadratic contracts with targets are called for.
Keywords: central bank independence, policy mix, fiscal rules, linear and quadratic contracts with targets
JEL Classification: E52, E61, E62
Suggested Citation: Suggested Citation