Central Bank Independence and the `Free Lunch Puzzle': A New Perspective

Ali al-Nowaihi (), Paul Levine () and Alex (Alexandros) Mandilaras

No 806, School of Economics Discussion Papers from School of Economics, University of Surrey

Abstract: A new perspective is provided on a puzzle that has emerged from the empirical lit- erature suggesting that government-independent central banks provide a `free lunch': lower in°ation is apparently achieved at no cost in terms of greater output variance. We assess the various explanations provided by the theoretical literature. After revis- iting the free lunch puzzle and con¯rming the empirical importance of open-economy effects, we develop a Rogoff-style delegation model that combines the latter with po- litical monetary cycle e®ects. We show that if all countries delegate monetary policy to government independent banks, as economies become more integrated then a low inflation, higher output variance trade-off re-emerges.

Keywords: central bank independence; open economy; political uncertainty (search for similar items in EconPapers)
JEL-codes: C72 E61 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2006-03
New Economics Papers: this item is included in nep-cba, nep-fmk, nep-mac, nep-mon and nep-pol
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Persistent link: https://EconPapers.repec.org/RePEc:sur:surrec:0806

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