A Nonnormative Theory of Inflation and Central Bank Independence

A Nonnormative Theory of Inflation and Central Bank Independence. - The authors study monetary policy under different central bank constitutions when the labor-market insiders set the minimal wage so that the outsiders are involuntarily unemployed. If the insiders are in the majority, the representative insider will be the median voter. The authors show that an independent central bank, if controlled by the median voter, does not produce a systematic inflation bias, albeit equilibrium employment is too low from a social welfare point of view. A dependent central bank, in contrast, is forced by the government to collect seigniorage and to take the government's re-election prospects into account. The predictions of their theory are consistent with the evidence that central bank independence decreases average inflation and inflation variabil-ity, but does not affect employment variability.