Designing Monetary Policy When Unemployment Persists.

This paper investigates how unemployment persistence affects the optimal delegation of monetary policy to an independent central banker (CB). Two opposing forces are shown to be at work: with more persistence, the government's incentive to stabilize the economy is greater; but (if the CB is forward-looking) its incentive to create inflation surprises is also greater. The authors show that, owing to the second effect, the government may wish not to delegate at all, unlike the case where there is no persistence. In the event that the government does delegate, the paper identifies conditions under which either effect dominates in the government's choice of conservatism of the CB. The authors compare delegation to discretion and precommitment, using a diagrammatic approach that may be of independent interest. They also present some preliminary empirical evidence on the cross-country relationship between unemployment persistence and inflation that appears consistent with the model's predictions. Copyright 1998 by The London School of Economics and Political Science