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Central Bank Communication and the Liquidity Trap

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  • STEFANO EUSEPI

Abstract

Central bank communication plays an important role in shaping market participants' expectations. This paper studies a simple nonlinear model of monetary policy where agents have incomplete information about the economic environment. It shows that agents' learning and the dynamics of the economy are heavily affected by central bank's transparency about its policy rule. A monetary authority that does not communicate its rule can induce “learning equilibria” where the economy experiences prolonged periods of deflation and slow growth. More generally, small expectational errors can result in complex economic dynamics, inducing welfare‐reducing fluctuations. On the contrary, central bank communication helps stabilizing expectations around the inflation target equilibrium.

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  • Stefano Eusepi, 2010. "Central Bank Communication and the Liquidity Trap," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 42(2‐3), pages 373-397, March.
    • Handle: RePEc:wly:jmoncb:v:42:y:2010:i:2-3:p:373-397
    DOI: 10.1111/j.1538-4616.2009.00291.x
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    Cited by:

    1. Eusepi, Stefano & Gibbs, Chris & Preston, Bruce, 2021. "Forward guidance with unanchored expectations," Bank of Finland Research Discussion Papers 11/2021, Bank of Finland.
    2. Goy, Gavin & Hommes, Cars & Mavromatis, Kostas, 2022. "Forward guidance and the role of central bank credibility under heterogeneous beliefs," Journal of Economic Behavior & Organization, Elsevier, vol. 200(C), pages 1240-1274.
    3. Yingying Xu & Zhixin Liu & Jingjing Chen & Sultan Salem, 2024. "How official TV news affect public inflation expectations? Evidence from the Chinese national broadcaster China Central Television," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 29(1), pages 819-831, January.

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