A Model of Politics and the Central Bank

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Abstract/Contents

Abstract: We present a two-period model examining how the central bank and the elected government jointly shape elections and economic outcomes. An apolitical central bank minimizes a quadratic loss function in inflation and unemployment along an expectational Phillips curve, which is shifted by the government’s quality. Fully rational voters optimally choose between the incumbent, whose quality they infer from unemployment, and a challenger of unknown quality. We find that governments prefer more inflation-averse central banks than the social planner, rationalizing the political success of inflation-targeting in practice. Inflation-targeting, however, has negative economic consequences by allowing lower quality incumbents to be reelected.

Type of resource	text
Date created	July 23, 2021

DOI	https://doi.org/10.25740/bj071jr8114
Location	https://purl.stanford.edu/bj071jr8114

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License: This work is licensed under a Creative Commons Attribution 4.0 International license (CC BY).

Preferred citation: Dziuda, W. and Pflueger, C. (2022). A Model of Politics and the Central Bank. Stanford Digital Repository. Available at https://purl.stanford.edu/bj071jr8114

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