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The Expected Interest Rate Path: Alignment of Expectations vs. Creative Opacity

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  • Pierre Gosselin

    (Institute Fourier, University of Grenoble)

  • Aileen Lotz

    (The Graduate Institute, Geneva)

  • Charles Wyplosz

    (The Graduate Institute, Geneva)

Abstract

We examine the effects of the release by a central bank of its expected future interest rate in a simple two-period model with heterogeneous information between the central bank and the private sector. The model is designed to rule out common-knowledge and time-inconsistency effects. Transparency—when the central bank publishes its interest rate path—fully aligns central bank and private-sector expectations about the future inflation rate. The private sector fully trusts the central bank to eliminate future inflation and sets the long-term interest rate accordingly, leaving only the unavoidable central bank forecast error as a source of inflation volatility. Under opacity—when the central bank does not publish its interest rate forecast—current-period inflation differs from its target not just because of the unavoidable central bank expectation error but also because central bank and privatesector expectations about future inflation and interest rates are no longer aligned. Opacity may be creative and raise welfare if the private sector’s interpretation of the current interest rate leads it to form a view of expected inflation and to set the long-term rate in a way that systematically offsets the effect of the central bank forecast error on inflation volatility. Conditions that favor the case for transparency are a high degree of precision of central bank information relative to private-sector information, a high precision of early information, and a high elasticity of current to expected inflation.

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Bibliographic Info

Article provided by International Journal of Central Banking in its journal International Journal of Central Banking.

Volume (Year): 4 (2008)
Issue (Month): 3 (September)
Pages: 145-185

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Handle: RePEc:ijc:ijcjou:y:2008:q:3:a:6

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References

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  1. Jordi Galí & Mark Gertler, 2007. "Macroeconomic Modeling for Monetary Policy Evaluation," NBER Working Papers 13542, National Bureau of Economic Research, Inc.
  2. Glenn D. Rudebusch & John C. Williams, 2006. "Revealing the Secrets of the Temple: The Value of Publishing Central Bank Interest Rate Projections," NBER Working Papers 12638, National Bureau of Economic Research, Inc.
  3. Pierre Gosselin, Aileen Lotz and Charles Wyplosz, 2007. "Interest Rate Signals and Central Bank Transparency," IHEID Working Papers 19-2007, Economics Section, The Graduate Institute of International Studies, revised Aug 2007.
  4. Todd E. Clark & Michael W. McCracken, 2007. "Averaging forecasts from VARs with uncertain instabilities," Finance and Economics Discussion Series 2007-42, Board of Governors of the Federal Reserve System (U.S.).
  5. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  6. Charles Goodhart, 2005. "The Interest Rate Conditioning Assumption," FMG Discussion Papers dp547, Financial Markets Group.
  7. Cukierman, Alex & Meltzer, Allan H, 1986. "A Theory of Ambiguity, Credibility, and Inflation under Discretion and Asymmetric Information," Econometrica, Econometric Society, vol. 54(5), pages 1099-1128, September.
  8. Carl E. Walsh, 2007. "Optimal Economic Transparency," International Journal of Central Banking, International Journal of Central Banking, vol. 3(1), pages 5-36, March.
  9. Lars E.O. Svensson, 2005. "Social Value of Public Information: Morris and Shin (2002) Is Actually Pro Transparency, Not Con," NBER Working Papers 11537, National Bureau of Economic Research, Inc.
  10. Christian Hellwig, 2004. "Heterogeneous Information and the Benefits of Public Information Disclosures (October 2005)," UCLA Economics Online Papers 283, UCLA Department of Economics.
  11. Giuseppe Ferrero & Alessandro Secchi, 2009. "The Announcement of Monetary Policy Intentions," Temi di discussione (Economic working papers) 720, Bank of Italy, Economic Research and International Relations Area.
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Cited by:
  1. Petra Geraats, 2014. "Monetary Policy Transparency," CESifo Working Paper Series 4611, CESifo Group Munich.
  2. Lars E.O. Svensson, 2010. "Inflation Targeting," NBER Working Papers 16654, National Bureau of Economic Research, Inc.
  3. Phan, Tuan, 2013. "Should Central Banks publish interest rate forecasts? - A Survey," MPRA Paper 44676, University Library of Munich, Germany, revised 01 Mar 2013.
  4. Marcello Miccoli, 2012. "Optimal dynamic public communication," Temi di discussione (Economic working papers) 856, Bank of Italy, Economic Research and International Relations Area.
  5. Nikola Mirkov & Gisle James Natvik, 2013. "Announcements of interest rate forecasts: Do policymakers stick to them?," Working Paper 2013/11, Norges Bank.

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