Independence of European System of Central Banks and the Macroeconomic Performances in Euro Zone

Abstract

This article provides the theoretical model to analyze the impact on the Euro Zone economy with focusing the relationship between the price target and the independence. The European System of Central Banks gives priority to the price stabilization, which is emphasized by Neo-classical Economics that suppose the perfect price adjustment. The Neo-classical economics proposes central bank independence in order to promote the central bank stabilize inflation more than variation of income. ESCB is also designed for high independence according to this view.
However, it must be investigated theoretically whether such ESCB is optimal in Euro zone, where price does not adjust perfectly at least shortterm. That is, trade-off between inflation and unemployment appears in the zone. This article pursues the optimal interest rate policy by ESCB faced the trade-off, such like the Keynesian economy with supply shock. ESCB is supposed to have the weighted lost function including the inflation and income fluctuation. Though Barro and Gordon model solves the optimal monetary policy under the Neo-classical economy with perfect price adjustment, our model gets the optimal monetary policy under the Keynesian economy with price rigidity. Our model suggests the supply shock affect the trade-off between inflation and income fluctuation.
Further, we pursue the optimal design for the ESCB by the mathematical simulation. Rogoff (1985) solves the optimal target weight between inflation and income with perfect price adjustment, whereas we get the optimal weight with price rigidity that is suitable for the Euro zone. From our conclusion, optimal weight between inflation and income fluctuation depends on the interest rate elasticity of income. So, ESCB should pay attention to not only price stabilization but also income fluctuation. In order for ESCB to have two targets optimally, the framework for accountability of ESCB should be adequate, to improve credibility of ESCB.