DESIGNING MONETARY POLICY WHEN UNEMPLOYMENT PERSISTS*
Paper number: 94/08
Paper date: October 19, 1995
Paper Category: Discussion Paper
Professor of Economics, University of Exeter, CEPR Research Fellow
Professor of Economics, University of Warwick, CEPR Research Fellow
PhD in Economics, University of Warwick, U.
This paper investigates how unemployment persistence affects the various proposals advanced as solutions to the problem of inflation bias (namely delegation, contracts and reputation). First, the contract solution is extended to cover the dynamic case. However, as such contracts are not used in practice, we focus on delegation solution. We find that the delegation of policy to a conservative Central Banker still proves attractive in a setting where unemployment persists; but the degree of conservatism depends critically on how the Central Banker discounts the future. Where the Central Banker discounts the future hardly at all, we find that the appropriate strategy is to delegate to candidates who are more conservative the more persistant is unemployment. Finally, we consider briefly how reputational factors might affect this result.
*Acknowledgements: We are grateful to Olga Arratibel and Martin Cripps of Warwick University for valuable discussions and suggestions. The usual disclaimer applies.
Correspondance to: Professor Ben Lockwood, Department of Economics, University of Exeter, Exeter EX4 4RJ. Tel. (44) 392 263219, Fax. (44) 392 263242.