Conservative central banks: how conservative should a central bank be?
| DOI | http://doi.org/10.1111/sjpe.12149 |
| Date | 01 February 2018 |
| Published date | 01 February 2018 |
CONSERVATIVE CENTRAL BANKS:
HOW CONSERVATIVE SHOULD A
CENTRAL BANK BE?
Andrew Hughes Hallett* and Lorian D. Proske**
ABSTRACT
Using Rogoff’s, 1985 model, we determine how inflation averse a central banker
should be, given the level of volatility and projected output gap in the economy.
We confirm a strong degree of conservatism, almost twice what society would have
chosen. But, for a range of developing countries and the OECD, economies that
systematically experience higher levels of output volatility would do best to hire a
central banker who is more inflation averse than society, but less so than in stable
developed economies. Thus, while a conservative central banker remains desirable,
the trade-off is with output volatility rather than with the output gap itself.
II
NTRODUCTION
One of the best known results in monetary policy is Rogoff’s theory of the con-
servative central bank [Rogoff, 1985]. This proposition appears in almost every
text book on monetary policy and states that inflation will be lower (closer to
target) and output more stable if the central bank is designed to have greater
inflation aversion than the electorate would have chosen for itself.
But just how much more conservative should the central bank be? That
question remains unanswered. We provide a formal answer, in both theory
and in practice. Using data for the OECD and 15 emerging market econo-
mies, we find inflation aversion should nearly double (preferences for output
stabilization halve); a result which is attenuated, in poorly managed econo-
mies, by the underlying degree of output volatility.
II ANOPTIMAL (CONSERVATIVE)CENTRAL BANK
We start from the classic objective (loss) function for an independent central
bank, extensively used in the central banking literature:
Min L¼1
2ðptptÞ2þby
tkðÞ
2
hi
ð1Þ
*George Mason University and University of St Andrews
**University of St Andrews
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12149, Vol. 65, No. 1, February 2018
©2017 Scottish Economic Society.
97
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