10
function.
Hence, optimal commitment in monetary policy involves trading off the credibility gains
associated with lower average inflation versus loss of flexibility due to a distorted response
to output shocks.
III.3. The Ultimate Determinants of Central Bank Independence
Proposition (3.1) is Rogoff’s theorem. Rogoff is unable to write down a closed-form
solution for ε*. Therefore, he is also unable to derive propositions concerning the
comparative static properties of this equilibrium. The following section can be seen as an
extension of the Rogoff theorem.
Using a graphical method, we develop an alternative way of determining the optimal
degree of central bank independence. Next, we show how this result is conditioned on the
natural rate of unemployment (U), society’s preferences for unemployment stabilization
(χ), the variance of productivity shocks (σμ2) and the slope of the Phillips curve ((1-β)^1).
By setting (3.3) equal to zero we obtain the first-order condition for a minimum of Et-1
LIt
0 = -dnI + -drI (3.6)
∂ε ∂ε
Substituting (3.4) and (3.5) into (3.6), yields
-χ2u2 + χ2(1 β )2e σμ = 0 (3.7)
(1 -β )2(1 + ε)3 [(1 + ε)(1 -β )2+χ]3
Equation (3.7) determines ε* as an implicit function of χ, u, σμ2 and β. A solution for ε*
always exists and is unique.
To show this we adapt a graphical method used by Cukierman (1992, pp. 170-172) in
the context of a dynamic game.
Rewrite (3.7) as
ɛ = [(1+εX1-β)2 + χ]3u2 ≡ F(g) (3.8)
⅛1 -β )4(1 +ɛ)3
The function F(ε) on the right-hand side of equation (3.8) is monotonically decreasing in
More intriguing information
1. Perfect Regular Equilibrium2. The name is absent
3. NATURAL RESOURCE SUPPLY CONSTRAINTS AND REGIONAL ECONOMIC ANALYSIS: A COMPUTABLE GENERAL EQUILIBRIUM APPROACH
4. The name is absent
5. Regulation of the Electricity Industry in Bolivia: Its Impact on Access to the Poor, Prices and Quality
6. The name is absent
7. Temporary Work in Turbulent Times: The Swedish Experience
8. The name is absent
9. Elicited bid functions in (a)symmetric first-price auctions
10. Business Networks and Performance: A Spatial Approach