Central Bank Independence in Transition Economies

instrument independence (Fisher 1995). 

A weak point of the Rogoff's model and the proceeding works is a postulate that 

the Government is able to choose the Banker whose preferences are common 

knowledge. The whole analysis hinges on the assumption that there is a continuum of 

potential Bankers' types, from which the Government chooses the most desired one 

whose type is immediately recognised by the private agents. The solution will be sub-

optimal if the Government nominates the “wrong” person. If the people need time to 

recognise the Banker's type, the asymmetric information problem is re-introduced as in 

the models developed by Backus and Driffill (1986) or Cukierman and Meltzer 

(1986). 

1.4.2. Alleviating the Credibility vs. Flexibility Trade Off 

A serious drawback of the Rogoff's solution to the time-inconsistency problem is 

that the Central Bank's responses to the supply shocks are not optimal for output 

stabilisation. This problem give rise to several extensions of the proposed delegation 

scheme.  

Flood and Isaard (1989) extended Rogoff (1985) model by specifying the rule for 

Central Bank's policy contingent on the value of the supply shock. In their model 

constant-inflation rule is followed in “normal” times but monetary expansion is 

positive when output shocks are large. Formally, the Central Bank's loss function is 

augmented by a positive constant, the cost of deviation from the rule, multiplied by a 

dummy variable which takes on the value of unity when reneging and zero otherwise. 

In the model presented by Lohmann (1992) policymakers grant only