Monetary Delegation: Credibility through Dynamic Incentives

We analyze delegation of monetary policy to an independent but accountable Central Banker (CB) in a setting with a dynamic Phillips curve. The paper describes a mechanism that resolves the government's time inconsistency problem. Our proposal closely resembles real-world institutional arrangements and delivers credible implementation of the social optimum by giving dynamic incentives to the CB. We show that delegation generates an inflation plan identical to the precom-mitment path when the cost of adjusting CB remuneration is negligible. When steady-state adjustment costs are nil, the government achieves perfect commitment in the steady-state. These results suggest that delegation is more robust as a commitment instrument than previously emphasized.