Monetary policy, credibility and central bank constitutions

Abstract

Although most macroeconomists agree that the control of inflation may involve losses of output, there is no consensus about why. New Classical economists, focusing on the issue of credibility, have identified incentive problems as important obstacles to price stability. On the contrary, many new Keynesians regard credibility problems as secondary. They focus on the microeconomic details of wage and price adjustments as potential sources of disinflationary costs. Yet, if the costs and the benefits of anti-inflationary policy are strictly related to the market structure of the economy, so will be the incentives tempting the monetary authority to inflate. Indeed, what we show in this thesis is that the microeconomic aspects of wage and price setting not only affect the costs (benefits) of credible disinflationary (inflationary) policy, but that they need to be considered to determine whether those disinflationary (inflationary) policies can be perceived as credible or not. Despite the relevance of this problem, the economic analysis of microfoundations has received little attention at the time of designing efficient resolutions for the credibility problem of monetary policy. This idea has been illustrated in different ways. First, Rogoff's idea of delegation does not seem very attractive, if the wage setting process appears to be dominated by insider workers. Moreover, we have underlined the difficulties that a country like Spain, with a highly distorted labour market, may face in fighting inflation. Second, interesting patterns of inflation and output behaviour may be generated by the interaction of both credibility problems and staggered wage setting. Finally, although the difficulties of implementing anti-inflationary policies are emphasised in all our examples, they are particularly severe when near-rational behaviour or, alternatively, costs of changing prices are taken into account