Inflation Targeting: Delegation and Coordination of Monetary Policy

This paper provides an empirical assessment of the implications of delegating monetary policy to a central bank. We argue that the theoretical literature justifying central bank independence is highly stylised and is deficient in that it assumes there is only a single policy instrument under the control of a single policymaking authority and it typically assumes rational expectations. We are able to address all of these issues in an empirical model based analysis with expectations determined by learning. We apply new optimisation techniques to investigate the possible loss in welfare from uncoordinated fiscal and monetary policies. Our results seem to imply that such losses are small if the two authorities pursue congruent objectives. However, we then show that a sub-optimal non-cooperative outcome can arise if the authorities have competing objectives.