CAN POLITICAL MONETARY CYCLES BE AVOIDED

This paper shows that political monetary cycles can be avoided in a mo netary regime with Walsh-type contracts. Such contracts were originall y proposed to eliminate the inflationary bias of discretionary monetar y policy. This requires some commitment mechanism to enforce the contr act and prevent its renegotiation, but here we rule this out. Instead, in the context of a monetary regime with an instrument-independent ce ntral bank and an inflation target (the goal) set by the government, W alsh contracts serve a different purpose: namely, they provide an effi cient signalling device that eliminates the political monetary cycle, results in the election of competent governments and increases social welfare. (C) 1998 Elsevier Science B.V. All rights reserved.