First, we modify the Barro-Gordon model so that a credibility-stabilization tradeoff will remain, even when a performance contract of the type envisaged by Walsh (1995) is imposed on the central bank governor. We do this by modeling a real interest rate bias along with the inflation bias. Then,...

A literature has grown up around papers by Kydland and Prescott (1977) and Barro and Gordon (1983) which shows how governments have an incentive to inflate the economy (to generate extra output) then the private sector will anticipate this and the economy will stick at a high inflation...