CENTRAL BANK INDEPENDENCE AND THE MONETARY INSTRUMENT PROBLEM

Authors

  • STEFAN NIEMANN,

    1. University of Essex, U.K.
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  • PAUL PICHLER,

    1. Oesterreichische Nationalbank, Austria
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  • GERHARD SORGER

    1. University of Vienna, Austria
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    • We thank the editor, Harold Cole, and three anonymous referees for their comments and suggestions that have substantially improved this article. We also thank Elisabeth Beckmann, Alejandro Cuñat, Alain Gabler, Christian Ghiglino, Michael Krause, and audiences at the Swiss National Bank and the Universities of Essex, Linz, and Rotterdam (Erasmus) for helpful comments. The views expressed in this article are solely the responsibility of the authors and do not necessarily reflect the views of the Oesterreichische Nationalbank. Please address correspondence to: Paul Pichler, Oesterreichische Nationalbank, Economic Studies Division, Otto-Wagner-Platz 3, A-1090 Vienna, Austria. E-mail: Paul.Pichler@oenb.at.


Abstract

We study the monetary instrument problem in a dynamic noncooperative game between separate, discretionary, fiscal and monetary policy makers. We show that monetary instruments are equivalent only if the policy makers' objectives are perfectly aligned; otherwise an instrument problem exists. When the central bank is benevolent while the fiscal authority is short-sighted relative to the private sector, excessive public spending and debt emerge under a money growth policy but not under an interest rate policy. Despite this property, the interest rate is not necessarily the optimal instrument.

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