Is it Welfare Improving to Insulate Monetary Policy from the Political Arena?

Juan Carlos Berganza

Working Papers from CEMFI

Abstract: This paper presents a two-party model in which partisan and opportunistic politicians have two options: (i) to reach an agreement with respect to the central banker before elections are held, which leads to elections becoming a toss up, or (ii) to let the citizens vote for their proposed central bankers, which endogenizes the probabilities of being elected. Parties want to appoint their ideal central bankers (partisan), they care about winning the elections (opportunistic), and they are risk-averse about the electoral results. The paper shows that, under some circunstances, both parties may be interested in leaving the appointment of the central banker out of the electoral contest. The party with higher a priori electoral prospects would be willing to reduce its probability of winning the elections after an agreement if the appointed central banker is close to its preferences and/or it is very worried about the consequences of the other party's victory. The party with poorer electoral prospects may agree on a less preferred central banker if this increases its probability of winning. It is also shown that an agreement in which both parties improve their welfare may be bad for some voters.

Date: 1999
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