Staff Reports

Dynamic Incentives and the Optimal Delegation of Political Power

Previous title: “The Politics of Central Bank Independence:
A Theory of Pandering and Learning in Government”
March 2005Number 205
Revised November 2006
JEL classification: E58, E61, H11, J45

Authors: Gauti Eggertsson and Eric Le Borgne

We propose a theory to explain why, and under what circumstances, a politician delegates policy tasks to a technocrat in an independent institution, and analyze under what conditions delegation is optimal for society. Our theory builds on Holmström's hidden effort principal-agent model. The election pressures faced by politicians, together with the absence of such pressures for technocrats, give rise to a dynamic incentive structure that formalizes two rationales for delegation, one advanced in the eighteenth century by Alexander Hamilton and the other in a 1998 work by Blinder. Delegation trades off the cost of having a possibly incompetent technocrat with a long-term job contract against the benefit of having a technocrat who (i) invests more effort into the specialized policy task and (ii) is better insulated from shifts in public opinion. A natural application of our framework leads to a new theory of central bank independence.

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