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Why Central Banks Announce their Objectives: Monetary Policy with Discretionary Signalling

  • Palmqvist, Stefan

    ()

    (University of California, Berkeley)

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    This paper analyzes the use of announcements of objectives or intentions, announcements which are common in implementation of monetary policy. To analyze such announcements, this paper uses a model in which there is asymmetric information over the central bank´s objectives. This informational asymmetry is represented by a stochastic inflation target, upon which only the central bank can condition its actions. Thus, the scope is set for signalling, and the use of announcements can be seen as a way for a central bank to signal its type. This paper assumes that a central bank can signal at its own discretion and shows that while central banks with high inflation targets never use announcements, central banks with low inflation targets occasionally, but not always, will choose to reveal their private information through an announcement. A first finding is that, contrary to what a cheap-talk equilibrium suggests, the announcements may be more precise the larger the central bank´s news. Moreover, this paper shows that the frequency of announcements is unambiguously increasing in the magnitude of the central bank´s news, something that goes well in line with what is typically found in actual implementation of monetary policy.

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    File URL: http://su.diva-portal.org/smash/get/diva2:328255/FULLTEXT01
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    Paper provided by Stockholm University, Institute for International Economic Studies in its series Seminar Papers with number 663.

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    Length: 28 pages
    Date of creation: 05 Jan 1999
    Date of revision:
    Handle: RePEc:hhs:iiessp:0663
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    1. Faust, J. & Svensson, L.E.O., 1998. "Transparency and Credibility: Monetary Policy with Unobservable Goals," Papers 636, Stockholm - International Economic Studies.
    2. Bennett T. McCallum & Edward Nelson, 2000. "Nominal Income Targeting in an Open-Economy Optimizing Model," NBER Working Papers 6675, National Bureau of Economic Research, Inc.
    3. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Working Papers in Applied Economic Theory 98-03, Federal Reserve Bank of San Francisco.
    4. 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.
    5. Lars E.O. Svensson, 1995. "Optimal Inflation Targets, `Conservative' Central Banks, and Linear Inflation Contracts," NBER Working Papers 5251, National Bureau of Economic Research, Inc.
    6. Svensson, L.E.O., 1998. "Open-Economy Inflation Targeting," Papers 638, Stockholm - International Economic Studies.
    7. 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.
    8. 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.
    9. In-Koo Cho & David M. Kreps, 1987. "Signaling Games and Stable Equilibria," The Quarterly Journal of Economics, Oxford University Press, vol. 102(2), pages 179-221.
    10. Svensson, L.E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Papers 646, Stockholm - International Economic Studies.
    11. David Backus & John Driffill, 1985. "Rational Expectations and Policy Credibility Following a Change in Regime," Review of Economic Studies, Oxford University Press, vol. 52(2), pages 211-221.
    12. Alesina, Alberto & Tabellini, Guido, 1988. "Credibility and politics," European Economic Review, Elsevier, vol. 32(2-3), pages 542-550, March.
    13. Stein, Jeremy C, 1989. "Cheap Talk and the Fed: A Theory of Imprecise Policy Announcements," American Economic Review, American Economic Association, vol. 79(1), pages 32-42, March.
    14. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
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