Inflationary Bias

Another potential problem with the coordination of monetary policy is that it can worsen the inflationary bias within each country. If the costs associated with this increased domestic inflation outweigh the gains due to policy coordination countries will prefer to go without coordination. A country can experience inflationary bias if its optimal long run monetary policy is time inconsistent. Policy coordination may increase the government's incentive to deviate from its optimal monetary policy. If this is perceived by the private sector it will increase its inflationary expectations resulting in an increased level of equilibrium inflation. Government may be tempted for a greater incentive to deviate from its long run optimal policy because such coordination can improve the trade-off facing the government over inflation and unemployment.