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Walsh’s Contract and Transparency about Central Bank Preferences for Robust Control

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  • Meixing DAI
  • Eleftherios SPYROMITROS

Abstract

Within a New Keynesian model subject to misspecification, we examine the quadratic contracts in a delegation framework where government and private agents are uncertain about central bank preferences for model robustness. We show that, in the case of complete transparency, the optimal penalty is decreasing in terms of the preference for robustness. In effect, a central bank reacts more aggressively to supply shocks when the model misspecification grows larger. Furthermore, beginning from the equilibrium of perfect transparency and assuming that the average preference for robustness is sufficiently high, the central bank has then an incentive to be less transparent in order to reduce the optimal penalty. Under similar conditions, we also find that greater opacity will increase inflation and output variability.

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Bibliographic Info

Paper provided by Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg in its series Working Papers of BETA with number 2007-30.

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Date of creation: 2007
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Handle: RePEc:ulp:sbbeta:2007-30

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Keywords: Walsh’s contract; robust control; model uncertainty; central bank transparency.;

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  1. Eijffinger, Sylvester & Tesfaselassie, Mewael F., 2007. "Central Bank forecasts and disclosure policy: Why it pays to be optimistic," European Journal of Political Economy, Elsevier, vol. 23(1), pages 30-50, March.
  2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1999. "The Science of Monetary Policy: A New Keynesian Perspective," CEPR Discussion Papers 2139, C.E.P.R. Discussion Papers.
  3. Kai Leitemo & Ulf Soderstrom, 2004. "Robust Monetary Policy in the New-Keynesian Framework," Working Papers 273, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  4. Jensen, Henrik, 2001. "Optimal degrees of transparency in monetary policymaking," Discussion Paper Series 1: Economic Studies 2001,04, Deutsche Bundesbank, Research Centre.
  5. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: II. Applications," NBER Working Papers 9420, National Bureau of Economic Research, Inc.
  6. Lars E.O. Svensson & Michael Woodford, 2004. "Implementing Optimal Policy through Inflation-Forecast Targeting," NBER Chapters, in: The Inflation-Targeting Debate, pages 19-92 National Bureau of Economic Research, Inc.
  7. Bennett T. McCallum, 1997. "Issues in the Design of Monetary Policy Rules," NBER Working Papers 6016, National Bureau of Economic Research, Inc.
  8. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  9. 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.
  10. Alex Cukierman, 2002. "Are contemporary central banks transparent about economic models and objectives and what difference does it make?," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 15-36.
  11. Walsh, Carl E, 2003. " Accountability, Transparency, and Inflation Targeting," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(5), pages 829-49, October.
  12. Hansen, Lars Peter & Sargent, Thomas J., 2003. "Robust control of forward-looking models," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 581-604, April.
  13. Marc P. Giannoni & Michael Woodford, 2003. "Optimal Interest-Rate Rules: I. General Theory," Levine's Bibliography 506439000000000384, UCLA Department of Economics.
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