DESIGNING MONETARY-POLICY WHEN UNEMPLOYMENT PERSISTS

This paper investigates how unemployment persistence affects the optim al delegation of monetary policy to an independent central banker (CB) . Two opposing forces are shown to be at work: with more persistence, the government's incentive to stabilize the economy is greater; but (i f the CB is forward-looking) its incentive to create inflation surpris es is also greater. We show that, owing to the second effect, the gove rnment may wish not to delegate at all, unlike the case where there is no persistence. In the event that the government does delegate, the p aper identifies conditions under which either effect dominates in the government's choice of conservatism of the CB. We compare delegation t o discretion and precommitment, using a diagrammatic approach that may be of independent interest. We also present some preliminary empirica l evidence on the cross-country relationship between unemployment pers istence and inflation that appears consistent with the model's predict ions.