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Interest Rate Signals and Central Bank Transparency

In: NBER International Seminar on Macroeconomics 2007

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Author Info

  • Pierre Gosselin
  • Aileen Lotz
  • Charles Wyplosz

Abstract

The present paper extends the literature on central bank transparency that relies on information heterogeneity among private agents in four directions. First, it adds the interest rate to the list of signals that the central bank can reveal. Second, it allows for more than one economic fundamental. Third, it extends the range of uncertainties that matter. So far the literature has focused on uncertainty about the economic fundamentals, assumed to be estimated with known precision; we also allow for uncertainty about precision. Fourth, it derives results that are general in the sense that they do not depend on any particular social welfare criterion. Each extension sheds new light on the role of central bank transparency. Focusing on the signaling role of the interest rate, we consider various degrees of transparency, ranging from full opacity, to just publishing the interest rate, to also revealing the signals and estimates of their precision. While uncertainty about the fundamentals results in the now familiar common knowledge effect, uncertainty about information precision creates a fog effect, which reduces the quality of decisions taken by the central bank and the private sector. In the absence of the fog effect, full transparency is generally not desirable, because it deprives the central bank from the ability to optimally manipulate private sector expectations. When the central bank's fog is large, we find that full transparency is usually the best communication strategy. This result tends to survive when the private sector's fog is large. Full opacity is only desirable when the central bank is poorly informed. Another result that emerges from our analysis is that it is usually desirable for the central bank to divulge some information, even if it is erroneous, and known to be erroneous. The reason is that, when the private sector knows that the central bank is mistaken, it needs to evaluate the extent of its mistakes.

(This abstract was borrowed from another version of this item.)

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This chapter was published in:

  • Richard Clarida & Francesco Giavazzi, 2009. "NBER International Seminar on Macroeconomics 2007," NBER Books, National Bureau of Economic Research, Inc, number clar07-1.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 2997.

    Handle: RePEc:nbr:nberch:2997

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    1. McCallum, Bennett T, 1995. "Two Fallacies Concerning Central-Bank Independence," American Economic Review, American Economic Association, vol. 85(2), pages 207-11, May.
    2. Geraats Petra M., 2005. "Transparency and Reputation: The Publication of Central Bank Forecasts," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-28, February.
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    6. Vickers, John, 1986. "Signalling in a Model of Monetary Policy with Incomplete Information," Oxford Economic Papers, Oxford University Press, vol. 38(3), pages 443-55, November.
    7. Stephen Morris & Jeffery D. Amato & Hyun Song Shin, 2004. "Communication and Monetary Policy," Yale School of Management Working Papers ysm345, Yale School of Management.
    8. Hyun Song Shin & Jeffery D. Amato, 2003. "Public and private information in monetary policy models," BIS Working Papers 138, Bank for International Settlements.
    9. John C. B. Cooper, 2004. "Dollarisation in Theory and Practice," World Economics, World Economics, Economic & Financial Publishing, 1 Ivory Square, Plantation Wharf, London, United Kingdom, SW11 3UE, vol. 5(4), pages 79-89, October.
    10. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    11. Christian Hellwig, 2004. "Heterogeneous Information and the Benefits of Public Information Disclosures (October 2005)," UCLA Economics Online Papers 283, UCLA Department of Economics.
    12. Petra M. Geraats, 2002. "Central Bank Transparency," Economic Journal, Royal Economic Society, vol. 112(483), pages 532-565, November.
    13. Stephen Morris & Hyun Song Shin, 2005. "Central Bank Transparency and the Signal Value of Prices," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(2), pages 1-66.
    14. Charles Bean, 2005. "Monetary Policy in an Uncertain World," World Economics, World Economics, Economic & Financial Publishing, 1 Ivory Square, Plantation Wharf, London, United Kingdom, SW11 3UE, vol. 6(1), pages 31-53, January.
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    Cited by:
    1. Eijffinger, Sylvester C W & Hoogduin, Lex & van der Cruijsen, Carin A B, 2008. "Optimal Central Bank Transparency," CEPR Discussion Papers 6889, C.E.P.R. Discussion Papers.
    2. James, Jonathan G. & Lawler, Phillip, 2010. "Macroeconomic shocks, unionized labour markets and central bank disclosure policy: How beneficial is increased transparency?," European Journal of Political Economy, Elsevier, vol. 26(4), pages 506-516, December.
    3. Alan S. Blinder & Michael Ehrmann & Marcel Fratzscher & Jakob De Haan & David-Jan Jansen, 2008. "Central Bank Communication and Monetary Policy: A Survey of Theory and Evidence," Journal of Economic Literature, American Economic Association, vol. 46(4), pages 910-45, December.
    4. Benjamin Born & Michael Ehrmann & Marcel Fratzscher, 2011. "Macroprudential policy and central bank communication," BIS Papers chapters, in: Bank for International Settlements (ed.), Macroprudential regulation and policy, volume 60, pages 107-110 Bank for International Settlements.
    5. Bernd Hayo & Matthias Neuenkirch, 2009. "Do Federal Reserve Communications Help Predict Federal Funds Target Rate Decisions?," MAGKS Papers on Economics 200925, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    6. Florin Cornel DUMITER & Horatiu Florin SOIM, 2012. "Bank of England’s monetary policy committee – assessing the importance and the implication upon monetary policy," Anale. Seria Stiinte Economice. Timisoara, Faculty of Economics, Tibiscus University in Timisoara, vol. 0, pages 61-67, May.
    7. Matthias Neuenkirch, 2011. "Central Bank Transparency and Financial Market Expectations: The Case of Emerging Markets," MAGKS Papers on Economics 201136, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    8. Jakob de Haan & David-Jan Jansen, 2009. "The communication policy of the European Central Bank: An overview of the first decade," DNB Working Papers 212, Netherlands Central Bank, Research Department.
    9. Alan Blinder, 2009. "Talking about monetary policy: the virtues (and vice?) of central bank communication," BIS Working Papers 274, Bank for International Settlements.
    10. Clemens J.M. Kool & Daniel L. Thornton, 2012. "How effective is central bank forward guidance?," Working Papers 2012-063, Federal Reserve Bank of St. Louis.
    11. Pierre Gosselin & Aileen Lotz & Charles Wyplosz, 2008. "The Expected Interest Rate Path: Alignment of Expectations vs. Creative Opacity," International Journal of Central Banking, International Journal of Central Banking, vol. 4(3), pages 145-185, September.

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