Abstract
This paper studies optimal monetary policy when the central bank lacks commitment to policies and is subject to privately observed, time-varying political pressure. We characterize the monetary rule that maximizes social welfare subject to the central bank's self-enforcement and private information constraints. Inflation responds to political shocks over time, with extreme shocks potentially triggering a temporary transition from a hawkish low-inflation regime to a dovish high-inflation regime. The threat of transitioning to the dovish regime sustains the hawkish regime, and the promise of returning to the hawkish regime sustains the dovish regime. We examine how inflation dynamics depend on the distribution of political shocks.
Full Citation
Independence, Credibility, and Communication of Central Banking
,
edited by ,
Chile
:
Central Bank of Chile
,
2020.