Optimal Contracts and Inflation Targets Revisited

Torsten Persson (torsten.persson@iies.su.se) and Guido Tabellini
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Torsten Persson: IIES, Stockholm University

No 436, Working Paper Series from Sveriges Riksbank (Central Bank of Sweden)

Abstract: We revisit the optimal-contract approach to the design of monetary institutions, in the light of the Zero Lower Bound (ZLB) on interest rates and the resort to Quantitative Easing (QE) in recent years. Four of our lessons have not yet been incorporated in the practices of inflation targeting central banks. First, the optimal contract and the implied inflation-targeting regime should condition on being at the ZLB or out of it. Second – as already argued by others – the optimal inflation target should be raised to deal with the possibility of being at the ZLB, and more so the greater the risk of being there. But this qualitative lesson does not appear to warrant major quantitative changes of inflation targets. Third, the relevance of the ZLB suggests that it may be desirable to expand central-bank mandates to encompass financial stability, broadly defined, besides price and output stability. Fourth, accountability for inflation performance is a central mechanism in a successful monetary-policy framework. How exactly to change those mechanisms in practice is a new and difficult challenge, which is at least as important as the search for optimal policy rules that has attracted so much recent attention.

Keywords: Inflation targets; optimal contracts; Zero lower bound (search for similar items in EconPapers)
JEL-codes: D02 E31 E58 H11 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2024-05-01
New Economics Papers: this item is included in nep-ban, nep-cba and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Working Paper: Optimal Contracts and Inflation Targets Revisited (2024)
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