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Institution Design for Macroeconomic Policy

Author

Listed:
  • Alexander Mihailov

    (Department of Economics, University of Reading)

  • Katrin Ullrich

    (KfW Bankengruppe, Frankfurt (Main))

Abstract

This paper explores the normative aspects of the institution design for macroeconomic policymaking when a society legislates specific objectives and sequencing of decisions for the involved authorities. We develop a general theoretical framework that adds fiscal policy to the flexibility-credibility trade-off well-established in monetary policy. We find that delegation of both monetary and fiscal policy to autonomous institutions of appointed experts improves macroeconomic outcomes by delivering lower average inflation and lower average public-sector deficit-to-output ratio over alternative policies conducted with interference by elected politicians. Yet greater independence of monetary and fiscal policymakers from the government also generates increased output variability around normal output. The latter effect is minor in magnitude, and the simulated expected social losses in all considered 24 institution-design regimes demonstrate the long-run welfare dominance of delegation of both monetary and fiscal policy to independent expert committees over joint government optimization. In addition, preannouncing an escape clause to be activated following extreme negative shocks may help mitigate short-run output and employment fluctuations, but at the cost of expected social losses that rise considerably.

Suggested Citation

  • Alexander Mihailov & Katrin Ullrich, 2015. "Institution Design for Macroeconomic Policy," Economics Discussion Papers em-dp2015-01, Department of Economics, University of Reading.
    • Handle: RePEc:rdg:emxxdp:em-dp2015-01
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    File URL: http://www.reading.ac.uk/web/FILES/economics/emdp2015116.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    delegation; independence; expert committees; monetary-fiscal interactions; policy games; institution design;
    All these keywords.

    JEL classification:

    • E02 - Macroeconomics and Monetary Economics - - General - - - Institutions and the Macroeconomy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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