Centralised Wage Setting, Inflation Contracts, and the Optimal Choice of Central Banker

The paper examines the appropriate design of central banking institutions in an economy in which the nominal wage is set by an inflation-averse monopoly union as a positive mark-up over its market-clearing value. The analysis considers both the optimal choice of central banker and the potential role for a linear inflation contract. The optimal set of arrangements is a central banker who attaches less significance to inflation than does society, combined with an inflation contract where the value of the contract parameter is related to the union's degree of inflation-aversion.     

ON THE SOURCES OF THE INFLATION BIAS AND OUTPUT VARIABILITY

Why do dynamic inconsistencies in monetary policy exist? In this paper, a traditional model with output 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. This paper shows that in this economy an inflation bias arises because of 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 with 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.     

Socially optimal monetary policy institutions

Research on the interaction between wage setters and central banks has shown that the classical dichotomy of monetary policy models in the tradition of Barro and Gordon [Journal of Political Economy 91 (1983) 589] does not hold if an inflation motive of wage setters is introduced. In this paper, the conditions for this result are re-examined under different assumptions concerning the exact timing of the strategic game, and the consequences for the socially optimal delegation rules and incentive contracts for central bankers are derived. It is shown that the relationship between central bank conservativeness and macroeconomic performance—and hence the design of optimal monetary policy institutions—is sensitive to the modelling choice. In particular, the case for an ultra-populist central banker is valid only under assumptions that appear to be quite unrealistic.     

Macroeconomic Performance and Wage Bargaining in a Monetary Union

Building on a micro-founded model of a two-region monetary union, this paperanalyses the macroeconomic impact of institutional reforms in labour marketsand central banking that may occur as a result of monetary unification. Thepaper shows that monopoly distortions in the labour market are a key factorin evaluating the effects of central bank's conservativeness and wagecentralisation on inflation and unemployment. Wage restraint is favoured ina highly decentralised wage bargaining setup as well as under a liberalcentral bank, provided competition is high in the labour market.     

The Interaction between the Central Bank and a Single Monopoly Union Revisited: Does Greater Monetary Policy Uncertainty Reduce Nominal Wages?

Previous papers modelling the interaction between the central bank and a single monopoly union demonstrated that greater monetary policy uncertainty reduces the union's nominal wage. This paper shows that this result does not hold in general, since it depends on peculiar specifications of the union's objective function. In particular, I show that greater monetary policy uncertainty raises the nominal wage whenever union members tend to be more sensitive to the risk of getting low real wages than to the risk of remaining unemployed. This conclusion appears consistent with the evidence showing that greater monetary authority's transparency reduces average inflation .     

Costly Information Acquisition and Delegation to a "Liberal" Central Banker

This paper develops a model of monetary policy in which the central banker can acquire costly information about a supply shock. It is shown that, with this assumption, it may be optimal for society to delegate to a "weight-liberal" central banker, a result which contrasts with that of Rogoff (1985). This result points at a limitation of Rogoff's argument. It may also explain why the issue of delegating monetary policy to an independent and "weight-conservative" central banker often is politically controversial.     

Monetary Institutions,Monopolistic Competition,Unionized Labor Markets and Economic Performance*

Recent literature on the interactions between labor unions and monetary institutions features either a supply or a demand channel of monetary policy, but not both. This leads to two opposing views about the effects of central bank conservativeness. We evaluate the relative merits of those conflicting views by developing a unified framework. We find that: (i) the effect of conservativeness on employment depends on unions’ relative aversion to unemployment versus inflation, and (ii) for plausible values of this relative aversion (and more than one union), social welfare is maximized under a highly conservative central bank. We also evaluate the effects of centralization of wage bargaining and product market competition on unemployment and inflation.     

Strategic wage setting, inflation uncertainty and optimal delegation

The paper examines optimal monetary policy delegation in an economy where wages are set strategically by a single economy-wide union whose objectives relate to employment and the real wage. Crucially, the central bank exerts imprecise control over inflation, giving rise to a positive relationship between the mean value of inflation and its variance. In this context, union concerns with regard to the employment goal render equilibrium sensitive to the conduct of monetary policy. As a consequence, optimal delegation arrangements closely resemble those identified as optimal in models that assume a direct aversion to inflation on the part of unions.     

Monetary Policy Delegation and Optimal Wage Indexation

This note shows that delegation of policy to a central banker who puts more weight on inflation stabilization than does the rest of society could reduce the alleged social inefficiency of private wage indexation decisions that arises in models of discretionary monetary policy.     

How strong is the case for a populist central banker? A note

Conventional wisdom holds that a conservative central banker reduces equilibrium inflation with no cost in terms of real activity. More recently, this proposition has been turned around in models with inflation averse wage setters who are Stackelberg leaders vis-à-vis the central bank: In this case a populist central banker with no interest in inflation was shown to lead to the first-best equilibrium. This note demonstrates that the Stackelberg assumption is crucial for this result and that the Nash solution of the same model does not generally support the case for a populist central banker.     

NOMINAL GDP TARGETING AND CENTRAL BANK CONSERVATIVENESS

In the literature on monetary economics, there is the ‘inflationary bias’ result which predicts that the rate of inflation will be biased towards a higher level under discretionary monetary policy than under a rule‐based policy regime. It is established that a credible nominal target can eliminate this ‘inflationary bias’. In this paper, we examine the case of nominal GDP targeting, which is a rule‐based monetary regime. Depending on the degree of conservativeness by the central bank, we show in a stylized model the choice of different combination of inflation and real GDP targets can still result in an ‘inflationary bias’, and there also exists the possibility of a ‘dis‐inflationary bias’.     

Conservative central banks: how conservative should a central bank be?

Using Rogoff's, 1985 model, we determine how inflation averse a central banker should be, given the level of volatility and projected output gap in the economy. We confirm a strong degree of conservatism, almost twice what society would have chosen. But, for a range of developing countries and the OECD, economies that systematically experience higher levels of output volatility would do best to hire a central banker who is more inflation averse than society, but less so than in stable developed economies. Thus, while a conservative central banker remains desirable, the trade‐off is with output volatility rather than with the output gap itself.     

Is a Conservative Central Banker a (Perfect) Substitute for Wage Coordination?

In a monetary union, macroeconomic policies are strongly associated with externalities that imply the need for coordination. However, if coordination is not complete, it might be unable to cope with the externalities. This paper investigates different solutions for internalizing policy externalities. In particular, we compare wage coordination to the conservative central banker solution, which the recent literature has found able to impose wage moderation on labor unions. We also discuss some issues related to labor flexibility reforms as a solution for the unemployment problem.     

Reputation building in a monetary policy game

This paper examines the notion of reputation building on the part of the central bank as a means of eliminating socially suboptimal inflation rates that arise in monetary policy games. The framework developed here explicitly models the behavior of wage setters, and it is shown that in the Nash equilibrium these private agents do not attain their desired outcome. Hence, wage setters have an incentive for engaging in a reputation-building game with the central bank. In this game, wage setters are allowed to select “optimally” a reputation based wage strategy, thereby making the strategy choice endogenous. This framework thus lays the groundwork for models in which the private sector behaves as a strategic player. It is shown that there exists a wage contract resembling an indexing arrangement which eliminates the suboptimal inflation rate. Finally, a discussion on the ways of restricting the number of permissible solutions to this game is presented.     

HOW CONSERVATIVE DOES THE CENTRAL BANKER HAVE TO BE? ON THE TREATMENT OF EXPECTATIONS UNDER DISCRETIONARY POLICYMAKING

This paper explores an issue that arises in the delegation process. The paper shows that a myopic central banker, one who treats expectations as constant in setting discretionary policy, can replicate the behaviour of output and inflation under policy from a timeless perspective. For that to happen, society must delegate a price level target or a speed limit policy to a central banker who is more weight-conservative than society.     

Inflation, government transfers, and optimal central bank independence

The problem of monetary policy delegation is formulated as a two-stage non-cooperative game between the government and the central bank. The solution to this policy game determines the optimal combination of central bank conservatism and independence. The results show that the optimal institutional design always requires some degree of central bank independence and that there is substitutability between central bank independence and conservatism. The results also show that partial central bank independence can be optimal and that there are circumstances under which it is optimal for the government to appoint a liberal central banker.     

The benefits of central bank's political independence

We consider a two-tier model of monetary policy where the central banker is both subject to the explicit influence of elected political principals through contracts and the implicit influence of interest groups willing to capture monetary policy. We analyze the impact of granting independence to the central banker on the scope for capture and the agency costs of delegating the monetary policy to a central banker. Political independence increases those agency costs but significantly stabilizes the politically induced fluctuations of inflation and improves ex ante social welfare.     

Optimal monetary policy revisited: does considering US real-time data change things?

The primary goal of this article is to investigate whether properly modelling real-time data and optimal real-time decision-making of a monetary planner provides new insights into monetary policy behaviour and outcomes. This article extends a variant of the asymmetric preference model suggested by Ruge-Murcia to investigate the use of real-time data available to policymakers when making their decisions and revised data which more accurately measure economic performance, but is only available much later. In our extended model, the central banker targets a weighted average of revised and real-time inflation together with a weighted average of revised and real-time output. Moreover, we allow for an asymmetric central bank response to real-time data depending on whether the unemployment rate is high or low. Our model identifies several new potential sources of inflation bias due to data revisions. Our empirical results suggest that the Federal Reserve Bank focuses on targeting revised inflation during low unemployment periods, but it weighs heavily real-time inflation during high unemployment periods. The inflation bias due to data revisions is comparable in magnitude to the bias from asymmetric central banker preferences with the bias being somewhat larger during high unemployment.     

MONETARY POLICY IN EMU WITH ASYMMETRIC TRANSMISSION AND NON-TRADABLE GOODS

Which policy objective should a central bank pursue in a monetary union with asymmetric monetary transmission and different rates of inflation? Should it base its decisions on the EU‐wide average of inflation and growth or should it instead focus on (appropriately weighted) national utility losses based on national rates of inflation and growth? We find that a policy which minimises the sum of national utility losses leads to higher average utility if the variability of common shocks is large relative to idiosyncratic demand shocks in the non‐tradables sectors. We draw conclusions for the appropriate weight of common and national objectives in the union.     

Is central bank conservatism desirable under learning?

In a New Keynesian model, we consider the delegation problem of the government when the central bank optimally sets discretionary monetary policy taking account of private expectations formed through adaptive learning. Learning gives rise to an incentive for the central bank to accommodate less the effect of inflation expectations and cost-push shocks on inflation and induces thus a deviation from rational expectations equilibrium. However, discretionary monetary policy under learning suffers from an excessively low stabilization bias. To improve the social welfare, the government should appoint a liberal central banker, i.e., set a negative optimal inflation penalty that decreases with the value of learning coefficient. The main conclusions are valid under both constant- and decreasing-gain learning.