Rogoff (1985) Conservative Central Banker

There has been a significant trend towards greater independence of Central Banks (Cukierman 2006,
Crowe & Meade 2008). Rogoff (1985) provides the theoretical basis for this movement in his
modelling of the German Bundesbank. This essay will first present Rogoffs model, and then show
how Lohmann (1992) improved upon this. Then evidence showing whether Rogoffs model is an
accurate representation of the German Bundebank will be discussed.
First this essay will present the Barro-Gordon model, which is then used by the Rogoff (1985) model:

Where governs the relative weight that the central bank places upon output expansions relative to
inflation stabilisations. is the growth rate of the money supply and is a velocity disturbance.
Rogoff (1985)
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Through the delegation of monetary policy to an independent central banker, Rogoff (1985) shows
that the Bundesbank can place a greater conservatism on inflation than society can and therefore
achieve a lower rate of inflation. Herrendorf and Lockwood (1997) and Walsh (2003) note
however that delegation to a weight conservative Central Banker will not entirely eliminate the entire
inflation bias on its own. This added conservatism however comes at the cost of lower output
stabilisation, thus resulting in a trade-off. If the costs of this lost output stabilisation are greater than
the benefits of lower inflation then the delegation of monetary policy to an independent central
banker would not be beneficial. In order for the inflation delivered by the conservative central bank
to be lower than that delivered by society, must be positive (shown in the diagram below). This
optimal is:
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Therefore welfare of society is improved with a conservative central banker, which can be achieved
through independence according to Rogoff (1985). This backs up the delegation of monetary policy
to the German Bundesbank.

Under the conservative central bank the variation in output is:

Lohmann (1992) instead argues that the existence of an escape clause results in the central bank
stabilising output more than the Rogoff model predicts at the margin of being overruled. Clearly
there is a cost to government of overruling the central bank. The central bank takes this cost into
account when making policy decisions and so makes decisions when output varies excessively so
that the government is indifferent about overruling them. This creates a region of independence to
pursue conservative central banking whilst this must be altered during swings of output to prevent
the occurrence of an overruling. This solves the problem that the Rogoff model has of showing an
inaccurate output variance.
Eijffinger and Hoeberichts (2002) develop Lohmanns model further and display it graphically.

Whilst the Bundesbank has not been directly overruled on its monetary policy, during the
reunification they were forced by the government of Helmut Kohl to give parity to the east and west
deutschmark (Walsh 2003). Furthermore adjustment of its unavoidable level of inflation to 4%
during the oil-price shocks of 1979 illustrates a scenario where conservatism was shelved to allow
for greater output stabilisation and remove the possibility of being overruled. Therefore, output is not
positively correlated with independence.
Furthermore, as Cruijsen and Eijffinger (2007) find, transparency widens this region of
independence as it reduces preference uncertainty. As such transparency in the model effectively
makes the central bank more conservative, and so is beneficial when attempting to reduce inflation.
Rogoff gained empirical support through the indices of Cukierman (1992) and De Hann and
Eijffinger (1994) who both concluded that the Bundesbank was one of the worlds most autonomous
central banks. Combining this result with Alesina and Summers (1993) seminal work
demonstrating a graphical negative relationship between central bank independence and inflation and
later more rigorous meta-regression analysis by De Hann and Klomp (2010) on studies between
1991 and 2006 confirming the same finding, one would be led to believe, that following the Rogoff
suggestion of independence would be beneficial in terms of inflation.
This model however fails to actually be an accurate representation of Germany. If it were accurate,
one would observe larger output variance in Germany than in similarly structured economies. Data
supporting this is hard to find. Whilst Alesina and Summers (1993) found advantages in Rogoffs
model, explained above, they did not find that output variance increases as monetary policy is
delegated, as Rogoff (1985) did.
When less developed economies are added to the analysis of Alesina and Summers (1993), the
central bank independence and inflation relationship breaks down (Cukierman 1992). Indeed after
controlling for other potential determinants of inflation, Campillo and Miron (1997) found little
role for central bank independence. As an example Cross (1994) demonstrates that the Russian
central bank in the 1990s did not reduce its levels of inflation upon gaining independence. Alesina
and Summer (1993) noted however that without a degree of political independence, appointing a
more inflation averse central banker may be impossible..
Whilst Lohmanns (1992) model introduces boundaries, which fix some of the issues of Rogoffs
(1985) model, it fails to completely to improve on the problem of the exportability of the
independence solution. Therefore it seems that Rogoff and Lohmanns model may only be suitable
for the German Bundesbank.
This model also fails to accurately represent Germany since it proposes having two separate reaction
functions: one for the conservative central banker, and another representing society. In reality the
conservative Bundesbanks reaction function, should be identical to that of society, since society
elected them (via the government) to represent their inflation preferences.
Hayo et al. (2004) find issue with the independence solution on the basis that independence is not
necessarily a proxy for conservatism (as Rogoff and Lohmann suggest in their models), since is
deeply rooted in the central bankers preferences and therefore may not be observable when a
government is interviewing for prospective conservative central bankers.
The inflation targeting approach, proposed by Walsh (1995) and Svennson (1997), removes this
problem of not knowing

, since a target is set, which if the central banker deviates from, results in
their punishment (where h is the punishment factor). This improvement allows for the model to
exported, since an algebraically identical solution can be implemented, without the need of a
conservative central bank, therefore giving the central bank some credibility in its decision making.
Credibility as empirically demonstrated by Ceccheti and Kause (2002) is key to reducing inflation.
The Rogoff model does not include credibility and therefore doesnt well represent the Bundesbank
as this was one of its defining characteristics.
Furthermore, Hallet et al. (2009) criticise the model for its omission of the interaction between
monetary and fiscal policy, which they show to affect the result of independent inflation targeting,
especially in light of the recent financial crisis.
Due to the problems of exporting this model and its inability to accurately represent Germany, tying
ones hands (Giovazzi and Pagano 1988) through currency pegging may be the only solution for
other countries wanting to replicate the Rogoff or Lohmann model by taking German preferences as
a conservative central bank and their own as society. This act would then satisfy Posens (2010)
criticism of the need for political support in the pursuit of low inflation, as this would have to be a
political decision.
There are other factors that one could discuss, but what the Rogoff model tells us is that if a central
banker can be ensured to be more inflation adverse than society then this will have a beneficial effect
on inflation. Also independence is widely accepted in practice and the literature to be a beneficial
characteristic of monetary policy. This is a solution that can be exported in tandem with further
policies to improve factors identified in the literature such as transparency and credibility.