Inflation Targeting: Revisiting the Delegation and Coordination of Monetary Policy

This paper investigates empirically the implications of delegating monetary policy to a central bank. We argue that the theoretical literature justifying central bank independence is highly stylised and is deficient in three respects: it typically ignores nominal or real rigidities, it assumes there is only a single policy instrument under the control of a single policymaking authority and it typically assumes rational expectations. All of these issues we are able to address in a model based analysis with expectations determined by learning. Firstly, we show how the inflation bias can be reduced by delegating monetary policy to the central bank. Second, and perhaps more importantly we apply new optimisation techniques to investigate the possible loss in welfare from uncoordinated fiscal and monetary policies. Our results seem to imply that such losses are small if the two authorities pursue congruent objectives. However, we show that a sub-optimal non-cooperative outcome can arise if the authorities have competing objectives.