Central Bank Independence in Transition Economies

Central Bank Independence… 

S&A No. 120 

11

parties, left- and right-wing. The parties have different, politically motivated, 

preferences on desired level of economic aggregates reflected in their loss functions. 

Left-wing party picks more monetary expansion either because it prefers more 

employment (Alesina and Sachs 1988) or to alleviate the disincentive effects of its 

redistributive policy (Havrilesky 1987). Output is determined by the Phillips curve like 

in eq. 1. Nominal contracts signed by the private agents before the election reflect the 

uncertainty on its results. Thus the expected inflation depends positively on the 

probability that the left-wing party will win the election and on the discrepancy 

between parties' preferences. After the election both parties partially accommodate 

inflationary expectations. The right-wing party inflates more (left-wing less) than 

ideologically desired to avoid excessive fluctuations of output. Later in office they 

return to preferred monetary expansion. The output deviation from the natural level is 

negative (positive) under the right-wing (left-wing) administration in the first period 

after the election. The economic variables fluctuations are caused by political changes.