Inflation bias, output stabilization and central bank independence

This study considers the inflation bias and the output consequences of discretionary monetary policy with and without central bank independence. Standard economic theory suggests that discretionary monetary policy leads to an inflation bias only if the policymaker pursues an output goal which exceeds natural output and that it does not affect the ability to stabilize output fluctuations. This study however shows that discretionary monetary policy can lead to an inflation bias even in the absence of an output goal exceeding natural output and that it can reduce the ability to stabilize output fluctuations. The models developed by the author offer new explanations for the occurrence of an inflation bias and for the relation between the degree of central bank independence and the variability of output. Thereby he points out that central bank independence is of greater importance than generally assumed in the relevant literature.