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Independent but Accountable: Walsh Contracts and the Credibility Problem

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  • Al-Nowaihi, A
  • Levine, Paul L

Abstract

Walsh (1995) addresses the government-central bank principal-agent problem where there exists a severe information extraction problem. This is solved by a ‘Walsh contract’ which links the income of the central bank to observed macroeconomic variables, output and inflation. The contract does not solve the time-inconsistency problem, however. There will be circumstances where a renegotiation of the contract benefits all parties involved and non-renegotiation-proofness destroys its credibility as a commitment device. But the contract’s strength is that renegotiation can be very visible and this facilitates a reputational solution to the problem, set out in this paper.

Suggested Citation

  • Al-Nowaihi, A & Levine, Paul L, 1996. "Independent but Accountable: Walsh Contracts and the Credibility Problem," CEPR Discussion Papers 1387, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:1387
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    Citations

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    Cited by:

    1. Rotondi, Zeno, 2000. "Designing instrument rules for monetary stability: the optimality of interest-rate smoothing," Discussion Paper Series In Economics And Econometrics 8, Economics Division, School of Social Sciences, University of Southampton.
    2. Persson, Torsten & Tabellini, Guido, 1999. "Political economics and macroeconomic policy," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 22, pages 1397-1482, Elsevier.
    3. Ms. Francesca Castellani & Mr. Xavier Debrun, 2001. "Central Bank Independence and the Design of Fiscal Institutions," IMF Working Papers 2001/205, International Monetary Fund.
    4. Rotondi, Zeno, 2000. "Credibility of optimal monetary delegation: do we really need prohibitive reappointment costs?," Discussion Paper Series In Economics And Econometrics 3, Economics Division, School of Social Sciences, University of Southampton.
    5. Carl E. Walsh, 2002. "When should central bankers be fired?," Economics of Governance, Springer, vol. 3(1), pages 1-21, March.
    6. Herrendorf, Berthold, 1998. "Inflation Targeting as a Way of Precommitment," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 431-448, July.
    7. Ali al-Nowaihi & Dean Garratt, 1998. "The New Political Macroeconomics," Discussion Papers in Economics 98/05, Division of Economics, School of Business, University of Leicester.
    8. al-Nowaihi, Ali & Levine, Paul, 1998. "Can political monetary cycles be avoided?," Journal of Monetary Economics, Elsevier, vol. 42(3), pages 525-545, October.
    9. Rotondi, Zeno, 2000. "Designing instrument rules for monetary stability: the optimality of interest-rate smoothing," Discussion Paper Series In Economics And Econometrics 0008, Economics Division, School of Social Sciences, University of Southampton.
    10. Marco Lossani & Piergiovanna Natale & Patrizio Tirelli, 2001. "Fiscal Policy and Inflation Targets: Does Credibility Matter?," Economia politica, Società editrice il Mulino, issue 3, pages 371-392.
    11. M. Lossani & P. Natale, & P. Tirelli, 1997. "Fiscal Policy and Imperfectly Credible Inflation Targets: Should We Appoint Expenditure-Conservative Central Bankers?," Working Papers 9707, Business School - Economics, University of Glasgow.
    12. Muscatelli, V Anton, 1998. "Political Consensus, Uncertain Preferences, and Central Bank Independence," Oxford Economic Papers, Oxford University Press, vol. 50(3), pages 412-430, July.
    13. Eric Dubois, 1998. "Taux d'intérêt réels élevés dans le monde et crédibilité des autorités monétaires," Revue Française d'Économie, Programme National Persée, vol. 13(1), pages 89-122.
    14. Rotondi, Zeno, 2000. "Credibility of optimal monetary delegation: do we really need prohibitive reappointment costs?," Discussion Paper Series In Economics And Econometrics 0003, Economics Division, School of Social Sciences, University of Southampton.

    More about this item

    Keywords

    Central Bank Contract; Credibility; Renegotiation; Reputation;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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