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The Expected Interest Rate Path: Alignment of Expectations vs. Creative Opacity

Author

Listed:
  • Pierre Gosselin

    (Institute Fourier, University of Grenoble)

  • Aileen Lotz

    (The Graduate Institute, Geneva)

  • Charles Wyplosz

    (The Graduate Institute, Geneva)

Abstract

We examine the effects of the release by a central bank of its expected future interest rate in a simple two-period model with heterogeneous information between the central bank and the private sector. The model is designed to rule out common-knowledge and time-inconsistency effects. Transparency—when the central bank publishes its interest rate path—fully aligns central bank and private-sector expectations about the future inflation rate. The private sector fully trusts the central bank to eliminate future inflation and sets the long-term interest rate accordingly, leaving only the unavoidable central bank forecast error as a source of inflation volatility. Under opacity—when the central bank does not publish its interest rate forecast—current-period inflation differs from its target not just because of the unavoidable central bank expectation error but also because central bank and privatesector expectations about future inflation and interest rates are no longer aligned. Opacity may be creative and raise welfare if the private sector’s interpretation of the current interest rate leads it to form a view of expected inflation and to set the long-term rate in a way that systematically offsets the effect of the central bank forecast error on inflation volatility. Conditions that favor the case for transparency are a high degree of precision of central bank information relative to private-sector information, a high precision of early information, and a high elasticity of current to expected inflation.

Suggested Citation

  • 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.
  • Handle: RePEc:ijc:ijcjou:y:2008:q:3:a:6
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    References listed on IDEAS

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    1. Jordi Galí & Mark Gertler, 2007. "Macroeconomic Modeling for Monetary Policy Evaluation," Journal of Economic Perspectives, American Economic Association, vol. 21(4), pages 25-46, Fall.
    2. Pierre Gosselin & Aileen Lotz & Charles Wyplosz, 2009. "Interest Rate Signals and Central Bank Transparency," NBER Chapters,in: NBER International Seminar on Macroeconomics 2007, pages 9-51 National Bureau of Economic Research, Inc.
    3. 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.
    4. Glenn D. Rudebusch & John C. Williams, 2008. "Revealing the Secrets of the Temple: The Value of Publishing Central Bank Interest Rate Projections," NBER Chapters,in: Asset Prices and Monetary Policy, pages 247-289 National Bureau of Economic Research, Inc.
    5. Giuseppe Ferrero & Alessandro Secchi, 2009. "The Announcement of Monetary Policy Intentions," Temi di discussione (Economic working papers) 720, Bank of Italy, Economic Research and International Relations Area.
    6. Christian Hellwig, 2004. "Heterogeneous Information and the Benefits of Public Information Disclosures (October 2005)," UCLA Economics Online Papers 283, UCLA Department of Economics.
    7. Todd E. Clark & Michael W. McCracken, 2010. "Averaging forecasts from VARs with uncertain instabilities," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 25(1), pages 5-29.
    8. Carl E. Walsh, 2007. "Optimal Economic Transparency," International Journal of Central Banking, International Journal of Central Banking, vol. 3(1), pages 5-36, March.
    9. Charles Goodhart, 2005. "The Interest Rate Conditioning Assumption," FMG Discussion Papers dp547, Financial Markets Group.
    10. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
    11. Lars E.O. Svensson, 2005. "Social Value of Public Information: Morris and Shin (2002) Is Actually Pro Transparency, Not Con," NBER Working Papers 11537, National Bureau of Economic Research, Inc.
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    Citations

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    Cited by:

    1. Michael Frenkel & Jin-Kyu Jung & Jan-Christoph Rülke, 2017. "Rationalizing the Bias in Central Banks' Interest Rate Projections," WHU Working Paper Series - Economics Group 17-03, WHU - Otto Beisheim School of Management.
    2. Svensson, Lars E.O., 2010. "Inflation Targeting," Handbook of Monetary Economics,in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 22, pages 1237-1302 Elsevier.
    3. repec:bla:jecsur:v:31:y:2017:i:3:p:678-711 is not listed on IDEAS
    4. Nikola Mirkov & Gisle James Natvik, 2016. "Announcements of Interest Rate Forecasts: Do Policymakers Stick to Them?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 48(5), pages 901-920, August.
    5. Marcello Miccoli, 2012. "Optimal dynamic public communication," Temi di discussione (Economic working papers) 856, Bank of Italy, Economic Research and International Relations Area.
    6. Lars E.O. Svensson, 2014. "Forward Guidance," NBER Working Papers 20796, National Bureau of Economic Research, Inc.
    7. Phan, Tuan, 2013. "Should Central Banks publish interest rate forecasts? - A Survey," MPRA Paper 44676, University Library of Munich, Germany, revised 01 Mar 2013.
    8. Lars E. O. Svensson, 2015. "The Possible Unemployment Cost of Average Inflation below a Credible Target," American Economic Journal: Macroeconomics, American Economic Association, vol. 7(1), pages 258-296, January.
    9. Petra Geraats, 2014. "Monetary Policy Transparency," CESifo Working Paper Series 4611, CESifo Group Munich.
    10. Richhild Moessner & David-Jan Jansen & Jakob de Haan, 2017. "Communication About Future Policy Rates In Theory And Practice: A Survey," Journal of Economic Surveys, Wiley Blackwell, vol. 31(3), pages 678-711, July.
    11. Lars E.O. Svensson, 2015. "Day One Keynote Address: Forward Guidance," International Journal of Central Banking, International Journal of Central Banking, vol. 11(4), pages 19-64, September.

    More about this item

    JEL classification:

    • D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy Formulation and Implementation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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