To deal with the time inconsistency problem associated with monetary policy, some have suggested that:
A) the central bank implement expansionary monetary policy prior to election years.
B) the contract of the central bank governor be reviewed regularly by the parliament.
C) elected officials should have a direct influence on the implementation of monetary policy.
D) the head of the central bank be chosen by election.
E) the central bank be made more independent.

Question

Quizplus · Accepted Answer

The best solution to address the time inconsistency problem associated with monetary policy is to make the central bank more independent. By doing so, the central bank can focus on achieving its primary goal of maintaining price stability without being influenced by short-term political pressures. This helps to anchor inflation expectations and provides a credible commitment to maintaining low and stable inflation, which is essential for promoting long-term economic growth and stability. Implementing expansionary monetary policy prior to election years or involving elected officials in the implementation of monetary policy could lead to a bias towards inflationary policies in the short run, which could damage the economy in the long run. Reviewing the contract of the governor by the parliament or electing the head of the central bank could lead to political interference, which could undermine the independence and credibility of the central bank. Therefore, the best choice is to make the central bank more independent.

To Deal with the Time Inconsistency Problem Associated with Monetary