INSTITUTIONAL CHECKS AND BALANCES AND THE POLITICAL CONTROL OF THE MONEY SUPPLY

The Nordhaus hypothesis about the political business cycle asserts tha t elected politicians have incentives to expand the money supply prior to elections to stimulate the economy and thereby engineer their re-e lection. Central bank independence is widely regarded as an institutio nal solution to this problem. However, this solution works only if cen tral bankers are not perfect agents of their political principals, per haps because they are conservative (more inflation-averse). This artic le proposes an alternative solution: political business cycles may be obstructed by institutional checks and balances. The analysis applies to the Deutsche Bundesbank and has implications for the institutional structure of the future European Central Bank.