CENTRAL BANKING AS A POLITICAL PRINCIPAL-AGENT PROBLEM |
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| Authors: | MICHELE FRATIANNI JÜRGEN VON HAGEN CHRISTOPHER WALLER |
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| Institution: | Indiana University Graduate School of Business, Bloomington, and Catholic University of Louvain, Phone 1–812-855-8679, Fax 1–812-855-3354 E-mail;University of Mannheim, Germany 68131 and Indiana University Graduate School of Business and CEPR, Bloomington, Phone 49–228-739199 Fax 49–228-739199 E-mail;Department of Economics, Indiana University, Bloomington Phone 1–812-855-8453, Fax 1–812-855-3736 E-mail |
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| Abstract: | Due to their ties with elected leaders, central bankers may pursue policies that are not in society's best interests. Consequently, the relationship between the public and the central bank can be characterized as a principal-agent problem. An inflation and stabilization bias arise as a result of this agency problem and the magnitudes of these biases depend on the political environment. Various institutional proposals for eliminating these biases are examined, and we find that central bank independence and performance contracts work best. However, we argue that central bank independence is preferable for resolving the agency problem. |
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