Central bank independence and public debt policy

The various proposals for the institutional design of the European Monetary Union have drawn fresh attention to the link between monetary and public debt policies. This paper explores the strategic interaction between fiscal authorities setting public debt and the central bank controlling monetary policy. In the absence of political distortions, an optimally designed conservative, independent central bank is sufficient to establish the second best. In the presence of political distortions or with coordination of monetary and fiscal policy, however, also a debt target is needed.