Showing papers by "Carl E. Walsh published in 1995"

Optimal contracts for central bankers

Abstract: This paper adopts a principal-agent framework to determine how a central banker's incentives should be structured to induce the socially optimal policy. In contrast to previous findings using ad hoc targeting rules, the inflation bias of discretionary policy is eliminated and an optimal response to shocks is achieved by the optimal incentive contract, even in the presence of private central-bank information. In the one-period model that has formed the basis for much of the literature on discretionary monetary policy, it is shown that the optimal contract ties the rewards of the central banker to realized inflation. Copyright 1995 by American Economic Association.

Is New Zealand's Reserve Bank Act of 1989 an Optimal Central Bank Contract?

Abstract: This paper evaluates the Reserve Bank of New Zealand Act of 1989 from a principal-agent perspective, arguing that the act represents a dismissal rule. The optimal dismissal rule requires that the central banker be dismissed whenever inflation exceeds a critical level that depends on aggregate supply disturbances and measurement error in the inflation index. This is essentially the structure established by the act. The scope for renegotiating the target rate, however, creates an incentive for the government to set the critical rate too high. Consequently, the inflation bias of discretion is reduced but not completely eliminated. Copyright 1995 by Ohio State University Press.

Recent Central-Bank Reforms and the Role of Price Stability as the Sole Objective of Monetary Policy

Abstract: Recent and prospective central banking reforms represent attempts to develop institutional solutions for the inflation bias that can arise under discretionary monetary policy. An alternative to mandated objectives or targeting requirements is offered by proposals to develop incentive contracts that base the central bank's rewards (or penalties) solely on the realized rate of inflation. Deriving optimal incentive schemes provides a normative benchmark against which central bank institutions can be compared. New Zealand's policy structure most resembles a performance contract; it has well-defined procedures for setting short-run targets and a system to ensure accountability. As yet, however, this system has not really been tested. In Europe, the emphasis has been on political independence. Less attention has been given to ensuring that the correct incentives for making short-run policy tradeoffs are established, nor has sufficient attention been placed on ensuring accountability.

Bank credit and economic activity

Abstract: The role of banks in regional as well as in national economic fluctuations has been the subject of renewed interest in recent years. With what seems like amazing prescience, Bernanke and Blinder (1988) recently revived the theoretical literature on the role of bank credit typically associated with Brunner and Meltzer (1972). The trickle of empirical papers written before the 1990s that focused on bank credit turned into a torrent during the 1990s. The primary impetus for this renewed interest was the 1990-91 recession, which seemed contemporaneously to have been distinguished by the large, and perhaps initiating, role played by reduced bank lending. Statements by government policymakers and the outpouring of research on the role of bank credit in macroeconomic fluctuations over the past five years generally indicated that banks’ capital shortfalls, whether due to regulatory changes or loan losses, reduced bank lending and were highly correlated with reduced output. The strong correlation between loans and output is long-standing. Indeed, the U.S. Department of Commerce classifies various measures of the dollar volume of business and consumer credit outstanding as lagging indicators of output, and it classifies various measures of the change in business and consumer credit as leading indicators of output.