Imperfect transparency and shifts in the central bank's output gap target
In the New Keynesian framework, the public's expectation about the future path of monetary policy is an important determinant of current economic conditions. This paper examines the impact of unobservable shifts in the central bank's output gap target on inflation and output dynamics. I show that when the degree of persistence of a shock is private information of the central bank, and policy is discretionary in nature, it is optimal for the central bank not to reveal the future expected path of the output gap target. Perfect transparency unambiguously increases inflation and output volatility and thus lowers welfare.
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