How Severe Is The Time-Inconsistency Problem in Monetary Policy?

The global financial crisis of 2007–2009 has changed the landscape for monetary policy. Many central banks in developed economies had to employ various unconventional policy tools to overcome a liquidity trap. These included large-scale asset purchase programs, forward guidance and negative interest rate policies. While recently, some central banks were able to return to conventional monetary policy, for many countries the effectiveness of unconventional policies remains an issue. In this paper we assess diverse practices of unconventional monetary policy with a particular focus on expectations and time consistency. The principal aspect of successful policy in terms of overcoming a liquidity trap is the confidence that interest rates will remain low for a prolonged period. However, forming such expectations faces the problem of time inconsistency of optimal policy. We discuss some directions to solve this problem.

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Monetary Policy

Theory of Macroeconomic Policy ◽

10.1093/oso/9780198825371.003.0007 ◽

2020 ◽

pp. 347-416

Author(s):

Christopher Tsoukis

Keyword(s):

Monetary Policy ◽

Inflation Targeting ◽

Formal Analysis ◽

Central Banks ◽

Time Inconsistency ◽

Stabilization Policy ◽

Taylor Rules ◽

Current Thinking ◽

Policy Transmission ◽

Institutional Architecture

This chapter discusses monetary policy. It is informally divided in two parts: The former discusses the rationale for and the main features of the current institutional ‘architecture’ related to monetary policy. A formal analysis of time inconsistency of optimal discretionary policy and the concomitant inflationary bias is followed by analyses of commitment and reputation. Subsequently, the Chapter looks at possible resolutions of the difficulties associated with discretionary policy, including independent Central Banks and inflation targeting. It also discusses the new features and proposals that emerged post-2007–9. A ‘policy in practice’ section looks at Taylor rules. In the latter part, we review the recent analyses on financial structure and the ‘credit channel(s)’ of monetary policy transmission. The chapter concludes with a review of Quantitative Easing, macroprudential regulation, and the current thinking on monetary policy as part of a wider package of optimal stabilization policy.

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Partisan and Electoral Motivations and the Choice of Monetary Institutions Under Fully Mobile Capital

International Organization ◽

10.1162/002081802760403757 ◽

2002 ◽

Vol 56 (4) ◽

pp. 725-749 ◽

Cited By ~ 27

Author(s):

William Roberts Clark

Keyword(s):

Monetary Policy ◽

Central Bank ◽

Exchange Rates ◽

Central Bank Independence ◽

Time Inconsistency ◽

Social Planner ◽

Fixed Exchange Rates ◽

Mobile Capital ◽

Wide Range ◽

Institutional Solution

Central bank independence and pegged exchange rates have each been viewed as solutions to the inflationary bias resulting from the time inconsistency of discretionary monetary policy. While it is obvious that a benevolent social planner would opt for such an institutional solution, it is less obvious that a real-world incumbent facing short-term partisan or electoral pressures would do so. In this article, I model the choice of monetary institutions from the standpoint of a survival-maximizing incumbent. It turns out that a wide range of survival-maximizing incumbents do best by forfeiting control over monetary policy. While political pressures do not, in general, discourage monetary commitments, they can influence the choice between fixed exchange rates and central bank independence. I highlight the importance of viewing fiscal policy and monetary policy as substitutes and identify the conditions under which survival-maximizing incumbents will view fixed exchange rates and central bank independence as substitutes. In so doing, I provide a framework for integrating other contributions to this volume.

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A Post-Keynesian Perspective on the Rise of Central Bank Independence

The Oxford Handbook of Post-Keynesian Economics, Volume 2 ◽

10.1093/oxfordhb/9780195390759.013.0013 ◽

2013 ◽

pp. 264-289

Author(s):

Joerg Bibow

Keyword(s):

Monetary Policy ◽

Central Bank ◽

Monetary Economics ◽

Central Banks ◽

Central Bank Independence ◽

Time Inconsistency ◽

Economic And Monetary Union ◽

Wide Range ◽

Historical Role ◽

The One

Central bank independence (CBI) refers to the relation between the central bank and the state, the legislature and executive. In practice, central banks typically engage in a wide range of activities related to the currency sphere and the financial system. The mainstream literature popularizing CBI features a “narrow central bank” approach that concentrates on central banks’ monetary policy functions only, ignoring important interdependencies between monetary policy on the one hand, and central banks’ historical role as government’s banker (as one link to fiscal policy) and their role in safeguarding the financial system’s stability on the other. This chapter investigates the rise in CBI as an apparent success story in modern monetary economics. The worldwide rise in CBI is partly due to the advent of Economic and Monetary Union (EMU) in Europe. This chapter also discusses the time-inconsistency argument for CBI, post-Keynesian criticisms of CBI, and whether John Maynard Keynes’s model of CBI strikes a sound balance between democracy and efficiency.

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