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Constrained Discretion and Central Bank Transparency

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  • Francesco Bianchi
  • Leonardo Melosi

Abstract

We develop a theoretical framework to quantitatively assess the general equilibrium effects and welfare implications of central bank reputation and transparency. Monetary policy alternates between periods of active infl‡ation stabilization and periods during which the emphasis on infl‡ation stabilization is reduced. When the central bank only engages in short deviations from active monetary policy, infl‡ation expectations remain anchored and the model captures the monetary approach described as constrained discretion. However, if the central bank deviates for a prolonged period of time, agents gradually become pessimistic about future monetary policy, the disanchoring of in‡flation expectations occurs, and uncertainty rises. Reputation determines the speed with which agents’' pessimism accelerates once the central bank starts deviating. When the model is fitted to U.S. data, we find that the Federal Reserve can accommodate contractionary technology shocks for up to five years before infl‡ation expectations take off. Increasing transparency would improve welfare by anchoring agents’' expectations. Gains from transparency are even more sizeable for countries whose central banks have weak reputation.

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Bibliographic Info

Paper provided by Duke University, Department of Economics in its series Working Papers with number 13-13.

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Length: 38
Date of creation: 2013
Date of revision:
Handle: RePEc:duk:dukeec:13-13

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Postal: Department of Economics Duke University 213 Social Sciences Building Box 90097 Durham, NC 27708-0097
Phone: (919) 660-1800
Fax: (919) 684-8974
Web page: http://econ.duke.edu/

Related research

Keywords: Bayesian learning; reputation; uncertainty; infl‡ation expectations; Markov-switching models; impulse response;

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References

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  1. Giorgio E. Primiceri, 2005. "Time Varying Structural Vector Autoregressions and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 821-852.
  2. Leonardo Melosi, 2012. "Signaling effects of monetary policy," Working Paper Series WP-2012-05, Federal Reserve Bank of Chicago.
  3. Troy Davig & Eric M. Leeper, 2005. "Generalizing the Taylor Principle," NBER Working Papers 11874, National Bureau of Economic Research, Inc.
  4. Francesco Bianchi, 2009. "Regime Switches, Agents’ Beliefs, and Post-World War II U.S. Macroeconomic Dynamics," 2009 Meeting Papers 198, Society for Economic Dynamics.
  5. Christopher A. Sims & Tao Zha, 2006. "Were There Regime Switches in U.S. Monetary Policy?," American Economic Review, American Economic Association, vol. 96(1), pages 54-81, March.
  6. Richard Clarida & Jordi Galí & Mark Gertler, 1997. "Monetary policy rules and macroeconomic stability: Evidence and some theory," Economics Working Papers 350, Department of Economics and Business, Universitat Pompeu Fabra, revised May 1999.
  7. Kristoffer Nimark, 2007. "Dynamic Pricing and Imperfect Common Knowledge," RBA Research Discussion Papers rdp2007-12, Reserve Bank of Australia.
  8. Jordi Galí & Mark Gertler, 2007. "Macroeconomic modeling for monetary policy evaluation," Economics Working Papers 1039, Department of Economics and Business, Universitat Pompeu Fabra, revised Jul 2007.
  9. Thomas A. Lubik & Frank Schorfheide, 2004. "Testing for Indeterminacy: An Application to U.S. Monetary Policy," American Economic Review, American Economic Association, vol. 94(1), pages 190-217, March.
  10. Frank Schorfheide, 2003. "Learning and monetary policy shifts," Working Paper 2003-23, Federal Reserve Bank of Atlanta.
  11. Christian Matthes & Argia M. Sbordone & Timothy Cogley, 2011. "Optimal Disinflation Under Learning," 2011 Meeting Papers 74, Society for Economic Dynamics.
  12. Rodriguez-Palenzuela, Diego & Castelnuovo, Efrem & Nicoletti-Altimari, Sergio, 2003. "Definition of price stability, range and point inflation targets: the anchoring of long-term inflation expectations," Working Paper Series 0273, European Central Bank.
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Cited by:
  1. Bianchi, Francesco & Melosi, Leonardo, 2013. "Modeling the Evolution of Expectations and Uncertainty in General Equilibrium," Working Paper Series WP-2013-12, Federal Reserve Bank of Chicago.
  2. Leonardo Melosi, 2013. "Signaling Effects of Monetary Policy," PIER Working Paper Archive 13-029, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  3. Francesco Bianchi & Leonardo Melosi, 2013. "Dormant Shocks and Fiscal Virtue," PIER Working Paper Archive 13-032, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  4. Francesco Bianchi & Cosmin Ilut, 2014. "Monetary/Fiscal Policy Mix and Agents' Beliefs," NBER Working Papers 20194, National Bureau of Economic Research, Inc.

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