Autore
Della Posta, Pompeo

Titolo
Central bank independence and public debt convergence in an open economy dynamic game
Periodico
European University Institute of Badia Fiesolana (Fi). Department of Economics - Working papers
Anno: 1997 - Fascicolo: 28 - Pagina iniziale: 1 - Pagina finale: 33

A realistic objective function for the atomistic central Bank and Treasury of a country adhering to a fixed exchange rate agreement like the EMS, would contain the public debt level, to be minimized for example to .meet one of the requirements contained in the Maastricht Treaty, and foreign reserves, that cannot go beyond a lower limit if the country does not want to renege on the exchange rate commitment. Both the Treasury and the Central Bank will then aim to reduce the level of debt, attempting to leave the burden of the adjustment on the others, while at the same time caring about the foreign reserves level. We assume that each authority decides optimally the variable under its own control by taking into account the decision rule of the others (Feedback-Nash equilibrium), so that we obtain a subgame perfect, and therefore time consistent, solution. Recent work on the subject has suggested the importance of independence of the Central Bank in order to increase the probability of success of a stabilization plan. Other contributions, however, argue that monetary independence may not be sufficient to induce fiscal discipline. In this paper we put forward a new argument leading to the conclusion that Central Bank independence might not be necessary to induce fiscal discipline: for this to be true it is enough that the fiscal authority assigns a high weight to the loss produced by foreign reserves variations. In the absence of "perverse" capital inflows, even with a dependent Central Bank, ready to inflate away part of the debt, the fiscal authority will act in a disciplined way to compensate the capital outflow produced by the monetary laxity. Some keywords: Central Bank independence, public debt convergence, dynamic game, Feedback-Nash equilibrium.



Testo completo: http://hdl.handle.net/1814/637

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