9309518 Walsh This project will explore insights that the principal-agent perspective can shed on the institutional design of monetary policy and central banks. Recent work suggests that important new insights can be gained from this approach. The contracting approach shows that problems of private information and the trade- off between inflation bias reduction and optimal stabilization may be solved by simple contracts that act to affect the incentives faced by the central bank. Perhaps most interestingly, these contracts look like targeting rules in which the central bank is penalized (or rewarded) on the basis of deviations around a target inflation rate or money growth rate. Since the targets depend on central bank announcements about its private information, these contracts are targeting rules with reporting requirements. As such, they bear a resemblance to the institutional structure of monetary policy in some countries. The research will extend the contracting approach to more closely study its implications for choosing among various performance measures for monetary policy defined over policy instruments (e.g., the monetary base), intermediate targets (e.g., the growth rate of a monetary aggregate) or final targets (e.g., the rate of inflation). The role of imperfect information on the central bank type will be examined to see how performance contracts might help to reveal information. In addition to addressing many other theoretical issues suggested by the contracting approach, the project will examine the empirical evidence on central bank design to determine the extent to which the empirical implications of the contracting approach might be reflected in the actual institutional structure of central banks. Recent work in monetary economics has suggested the importance of designing institutional structures that grant a large degree of independence to the central bank. This work has had an impact on the proposed design of a European Central Bank. No existing central banks have been granted complete independence. If greater independence leads to low inflation but undesired fluctuations in real economic activity, it is important to examine other approaches that might lead to new insights that could be applied to the problem of designing monetary policy institutions. ***
