The Impact of Central Bank Independence and Preferences on Inflation Targeting in Rule-Based and Discretionary Monetary Policy Approaches

Document Type : Research Paper


Vali-e-Asr University of Rafsanjan


This study investigates the impact of central bank autonomy and preferences on inflation targeting within rule-based and discretionary monetary policy frameworks. Due to rational expectations, discretionary policies often lead to time inconsistency and inflationary biases. Increasing central bank independence and aligning preferences with inflation control are proposed as solutions to mitigate these biases. This study analyzes central bank preferences in rule-based and discretionary policies using a general equilibrium approach and conducts simulations. Results indicate that inflation rates are lower under rule-based policies and that increasing the central bank's conservatism and preferences reduces inflation. Additionally, econometric models show a negative relationship between central bank independence and inflation in both developed and developing countries


Main Subjects

  1. Abbasinejad, H., Gudarzi, H., & Jalili Kamju, S. (2017). Studying the Effect of Time Inconsistency on Inflation in Iran Using the FMOC Approach. The journal of Economic policy, 8(16), 135-157 (In Persian).
  2. Agoba, A. M., Abor, J., Osei, K. A., & Sa-Aadu, J. (2017). Central bank independence and inflation in Africa: The role of financial systems and institutional quality. Central Bank Review, 17(4), 131-146.‏
  3. Ahmad Bhat, A., Iqbal Khan, J., Ahmad Bhat, S., & Ahmad Bhat, J. (2023). Central Bank Independence and Inflation in India: The Role of Financial Development. Studies in Economics and Econometrics, 47(4), 392-407.
  4. Barro, R. J., & Gordon, D. B. (1983). A positive theory of monetary policy in a natural rate model. Journal of political economy, 91(4), 589-610.‏
  5. Barro, R. J., & Gordon, D. B. (1983). Rules, discretion and reputation in a model of monetary policy. Journal of monetary economics, 12(1), 101-121.‏
  6. Bastanifar, I. (2015). Test of Time inconsistency of Iran’s Economy. Journal of Economic Research,49(4), 699-727 (In Persian).
  7. Brainard, W. C. (1967). Uncertainty and the Effectiveness of Policy. The American Economic Review, 57(2), 411-425.‏
  8. Breen, E. (2012). Reputation, credit and monetary policy, a brief review of the theoretical literature presented in the field of the role of reputation and credit in the implementation of monetary policy. New Economics Quarterly, 10(140),28-31.
  9. Calvo, G. A. (1978). On the time consistency of optimal policy in a monetary economy. Econometrica: Journal of the Econometric Society, 46(6), 1411-1428.‏
  10. Canzoneri, M. (1985). Monetary Policy Games and The Role of Private Information. The American Economic Review, 75(5), 1056-1069.‏
  11. Caputo, R., & Pedersen, M. (2020). The changing nature of the real exchange rate: The role of central bank preferences. Economic Modelling, 90(C), 445-464
  12. Carlson, J. B. (1988). Rules versus discretion: making a monetary rule operational. Economic Review-Federal Reserve Bank of Cleveland, 24(3), 2.‏
  13. Chesang, L. K., & Naraidoo, R. (2016). Parameter uncertainty and inflation dynamics in a model with asymmetric central bank preferences. Economic Modelling, 56(C), 1-10.‏
  14. Clarida, R., Gali, J., & Gertler, M. (1999). The science of monetary policy: a new Keynesian perspective. Journal of economic literature, 37(4), 1661-1707.‏
  15. Friedman, M. (1959). A Program for Monetary Stability, New York: Fordham University Press.
  16. Garriga, A. C., & Rodriguez, C. M. (2020). More effective than we thought: Central bank independence and inflation in developing countries. Economic Modelling, 85, 87-105.‏
  17. Givens, G. E. (2012). Estimating central bank preferences under commitment and discretion. Journal of Money, credit and Banking, 44(6), 1033-1061.‏
  18. Karimpour, Ali (2010). An analysis of time inconsistency and inflation in Iran. Master's thesis, Faculty of Economics, University of Tehran (In Persian).
  19. Khalili Araghi, M., &   Rahimzadeh Namvar, M. (2019). The time inconsistency of monetary policies and its effect on the exchange rate fluctuation in Iran. The journal of Economic policy, 11(21), 217-240 (In Persian).
  20. Khorsandi, M., & Islamloeian, K. (2012). Rule vs. Discretionary Monetary Policy: A Theoretical Analysis toward Selecting Appropriate Strategy. The Quarterly Journal of Economic Strategy, 1(1), 107-124 (In Persian).
  21. Komijani, A., Elahi, N., & Salehi Rezveh, M. (2015). Asymmetric Effects of the Monetary Policy on Inflation and Output Gap in Iran: A Threshold Approach. Economic Growth and Development research (EGDR), 6(21).61-78 (In Persian).
  22. Kydland, F. E., & Prescott, E. C. (1977). Rules rather than discretion: The inconsistency of optimal plans. Journal of political economy, 85(3), 473-491.‏
  23. Lotfi, Z., Sadeghi, H., & Faraji Dizaji, S. (2021). The impact of oil rents and corruption on central bank independence in oil exporting countries. Journal of Economic Research and Policies, 29(98), 417-445 (In Persian).
  24. Mahmoudinia, D., Dalali Isfahani, R., & Bakhshi Dastjerdi, R. (2015). Fundamental achievements in game theory and the role of game theory in the strategic confrontation between financial and monetary policy makers. PhD Thesis, University of Isfahan (In Persian).
  25. Mahmoudinia, D., Dallali Esfahani, R., Engwerda, J., & Bakhshi Dastjerdi, R. (2016) Game theory and its role in determining optimal policies and strategic interaction between fiscal and monetary policymakers (Application of differential game theory and stackelberg games). Quartely Journal of Applied Economics Studies, 5(18), 1-34 (In Persian).
  26. Nguyen, N., & Dang, T. (2022) The relationship between central bank independence and systemic fragility: global evidence. Cogent Economics & Finance, 10(1), 2087290, DOI: 10.1080/23322039.2022.208729
  27. Nourahmadi, M., Khademalizadeh, A., & Shirmehenji, M. (2022). Meta-Analysis of the Effect of Central Bank Independence on Inflation. Iranian Journal of Economic Research,27(92), 113-152 (In Persian).
  28. Orphanides, A. (2007). Taylor Rules’, Finance and Economics Discussion Series, Federal Reserve Board, 18.  Board of Governors of the Federal Reserve System (U.S.).
  29. Palma, A. A., & Portugal, M. S. (2011). Preferences of the central bank of Brazil under the inflation targeting regime: commitment vs. discretion. Revista Brasileira de Economia, 65(4), 347-358.‏
  30. Qanas, J., & Sawyer, M. (2023). ‘Independence’of Central Banks and the Political Economy of Monetary Policy. Review of Political Economy, 1-16.‏
  31. Rogoff, Kenneth. (1985). The Optimal Degree of Commitment to an Intermediate Monetary Target. Quarterly Journal of Economics, 100(4), 1169–1189.
  32. Romelli, D. (2022). The political economy of reforms in Central Bank design: evidence from a new dataset. Economic Policy, 37(112), 641-688.‏
  33. Samimi, A. J., & Derakhshani, K. (2015). Central Bank Independence in Iran: A Theoretical and Empirical Analysis. JMBR - Journal of Monetary & Banking Research, 8(24), 167-190 (In Persian).
  34. Simons, H. C. (1936). Rules versus authorities in monetary policy. Journal of Political Economy, 44 (1), 1-30.
  35. Tavakolian, H., & Sarem, M. (2016). DSGE patterns in DYNARE software (modelling, solving and estimation based on Iran's economy). Monetary and Banking Research Institute of the Central Bank of the Islamic Republic of Iran (In Persian).
  36. Walsh, C. E. (1995). Optimal contracts for central bankers. The American Economic Review,85(1), 150-167.‏
  37. Walsh, C. E. (2017). Monetary theory and policy. MIT press.
  38. Woodford, M. (1999). Optimal monetary policy inertia. NBER Working Papers 7261, National Bureau of Economic Research, Inc