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Transparency and credibility: monetary policy with unobservable goals

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Author Info
Jon Faust
Lars E.O. Svensson

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Abstract

We define and study transparency, credibility, and reputation in a model where the central bank's characteristics are unobservable to the private sector and are inferred from the policy outcome. A low-credibility bank optimally conducts a more inflationary policy than a high-credibility bank, in the sense that it induces higher inflation, but a less expansionary policy in the sense that it induces lower inflation and employment than expected. Increased transparency makes the bank's reputation and credibility more sensitive to its actions. This has a moderating influence on the bank's policy. Full transparency of the central bank's intentions is generally socially beneficial, but frequently not in the interest of the bank. Somewhat paradoxically, direct observability of idiosyncratic central bank goals removes the moderating incentive on the bank and leads to the worst equilibrium.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 605.

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Date of creation: 1998
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Handle: RePEc:fip:fedgif:605

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Keywords: Monetary policy;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Lewis, Karen K, 1991. "Why Doesn't Society Minimize Central Bank Secrecy?," Economic Inquiry, Oxford University Press, vol. 29(3), pages 403-15, July.
  2. Jeffrey C. Fuhrer, 1994. "Optimal monetary policy and the sacrifice ratio," Conference Series ; [Proceedings], Federal Reserve Bank of Boston, pages 43-84. [Downloadable!]
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  4. Jon Faust, 1992. "Whom can we trust to run the Fed? Theoretical support for the founders' views," International Finance Discussion Papers 429, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  5. McCallum, Bennett T., 1997. "Crucial issues concerning central bank independence," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 99-112, June. [Downloadable!] (restricted)
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  6. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August. [Downloadable!] (restricted)
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  7. King, Mervyn, 1997. "Changes in UK monetary policy: Rules and discretion in practice," Journal of Monetary Economics, Elsevier, vol. 39(1), pages 81-97, June. [Downloadable!] (restricted)
  8. Ben Bernanke & Frederic Mishkin, 1992. "Central Bank Behavior and the Strategy of Monetary Policy: Observations from Six Industrialized Countries," NBER Chapters, in: NBER Macroeconomics Annual 1992, Volume 7, pages 183-238 National Bureau of Economic Research, Inc. [Downloadable!]
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  9. Canzoneri, Matthew B, 1985. "Monetary Policy Games and the Role of Private Information," American Economic Review, American Economic Association, vol. 75(5), pages 1056-70, December. [Downloadable!] (restricted)
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  10. Svensson, Lars E O, 1995. "Optimal Inflation Targets, 'Conservative' Central Banks, and Linear Inflation Contracts," CEPR Discussion Papers 1249, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  11. Goodfriend, Marvin, 1986. "Monetary mystique: Secrecy and central banking," Journal of Monetary Economics, Elsevier, vol. 17(1), pages 63-92, January. [Downloadable!] (restricted)
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  12. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March. [Downloadable!] (restricted)
  13. 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. [Downloadable!] (restricted)
  14. Bennett T. McCallum, 1983. "On Non-Uniqueness in Rational Expectations Models: An Attempt at Perspective," NBER Working Papers 0684, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Fischer, Stanley, 1990. "Rules versus discretion in monetary policy," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 2, chapter 21, pages 1155-1184 Elsevier. [Downloadable!] (restricted)
  16. Laurence Ball, 1994. "What Determines the Sacrifice Ratio?," NBER Chapters, in: Monetary Policy, pages 155-193 National Bureau of Economic Research, Inc. [Downloadable!]
  17. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June. [Downloadable!] (restricted)
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  18. Alesina, Alberto & Tabellini, Guido, 1988. "Credibility and politics," European Economic Review, Elsevier, vol. 32(2-3), pages 542-550, March. [Downloadable!] (restricted)
  19. Persson, Torsten & Tabellini, Guido, 1993. "Designing institutions for monetary stability," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 53-84, December. [Downloadable!] (restricted)
  20. 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. [Downloadable!] (restricted)
  21. N. Gregory Mankiw, 1994. "Monetary Policy," NBER Books, National Bureau of Economic Research, Inc, number greg94-1, September.
  22. Backus, David & Driffill, John, 1985. "Inflation and Reputation," American Economic Review, American Economic Association, vol. 75(3), pages 530-38, June. [Downloadable!] (restricted)
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