Monetary Stabilization of a Multi-Sector Economy: Adding Words to Action?

In a multi-sector economy, conventional monetary policy alone is insufficient for achieving optimal economic stabilization. We examine whether a central bank can leverage private information about economic conditions to enhance policy effectiveness and improve outcomes. Our normative analysis emphasizes that the central bank should refrain from manipulating private beliefs and, if disclosure is optimal, should communicate information truthfully. However, such a communication policy is generally not credible, as even a benevolent policymaker faces sequential incentives to influence the beliefs of price-setting firms to reduce price dispersion and its negative welfare effects. In the absence of commitment, reputation becomes crucial in shaping these incentives. Specifically, a policymaker who strategically discloses information may secure significant stabilization gains during her term, but at the cost of long-term economic inefficiency.