Money, Banking and Financial Markets

Primers

Primers

 
 
Posts tagged Central bank independence
Time Consistency: A Primer

The problem of time consistency is one of the most profound in social science. With applications in areas ranging from economic policy to counterterrorism, it arises whenever the effectiveness of a policy today depends on the credibility of the commitment to implement that policy in the future.

For simplicity, we will define a time consistent policy as one where a future policymaker lacks the opportunity or the incentive to renege. Conversely, a policy lacks time consistency when a future policymaker has both the means and the motivation to break the commitment.

In this post, we describe the conceptual origins of time consistency. To emphasize its broad importance, we provide three economic examples—in monetary policy, prudential regulation, and tax policy—where the impact of the idea is especially notable....

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Steve Cecchetti and Kim SchoenholtzPrimer, Time consistency, Dynamic inconsistency, Strategy, Policy commitment, Credibility, Rules vs. discretion, Constrained discretion, Institutional design, Policy framework, Transparency, Communications, Monetary policy, Central bank independence, Inflation targeting, Inflation, Inflation expectations, Too big to fail, TBTF, Bailout, Capital requirements, Resolution, Stress test, Taxation, Capital, Tax treaty, Fiscal sustainability, Investment treaty
A Primer on Central Bank Independence

Central bank independence is controversial. It requires the delegation of powerful authority to a group of unelected officials. In a democracy, this anomaly naturally raises questions of legitimacy. It also raises fears of the concentration of power in the hands of a select few.

An independent central bank is a device to overcome the problem of time consistency: the concern that policymakers will renege in the future on a policy promise made today ....

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Steve Cecchetti and Kim SchoenholtzMonetary policy, Financial stability, Time consistency, Central bank independence, Macroprudential regulation, Delegation, Democracy, Transparency, Accountability, Primer