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Independent but Accountable: Walsh Contracts and the Credibility Problem

Ali al-Nowaihi () and Paul Levine ()

No 1387, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Walsh (1995) addresses the government-central bank principal-agent problem where there exists a severe information extraction problem. This is solved by a ‘Walsh contract’ which links the income of the central bank to observed macroeconomic variables, output and inflation. The contract does not solve the time-inconsistency problem, however. There will be circumstances where a renegotiation of the contract benefits all parties involved and non-renegotiation-proofness destroys its credibility as a commitment device. But the contract’s strength is that renegotiation can be very visible and this facilitates a reputational solution to the problem, set out in this paper.

Keywords: Central Bank Contract; Credibility; Renegotiation; Reputation (search for similar items in EconPapers)
JEL-codes: C72 E61 (search for similar items in EconPapers)
Date: 1996-04
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