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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
    Contact details of provider: Postal: Institute for International Economic Studies, Stockholm University, S-106 91 Stockholm, Sweden
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    Fax: +46-8-161443
    Web page: http://www.iies.su.se/

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    1. Svensson, Lars E.O., 1998. "Inflation Targeting as a Monetary Policy Rule," Seminar Papers 646, Stockholm University, Institute for International Economic Studies.
    2. Alesina, Alberto & Tabellini, Guido, 1988. "Credibility and politics," European Economic Review, Elsevier, vol. 32(2-3), pages 542-550, March.
    3. 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.
    4. Backus, David & Driffill, John, 1985. "Rational Expectations and Policy Credibility Following a Change in Regime," Review of Economic Studies, Wiley Blackwell, vol. 52(2), pages 211-21, April.
    5. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters, in: Monetary Policy Rules, pages 203-262 National Bureau of Economic Research, Inc.
    6. Svensson, Lars E. O., 2000. "Open-economy inflation targeting," Journal of International Economics, Elsevier, vol. 50(1), pages 155-183, February.
    7. In-Koo Cho & David M. Kreps, 1997. "Signaling Games and Stable Equilibria," Levine's Working Paper Archive 896, David K. Levine.
    8. Faust, Jon & Svensson, Lars E O, 2001. "Transparency and Credibility: Monetary Policy with Unobservable Goals," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(2), pages 369-97, May.
    9. 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.
    10. 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.
    11. McCallum, B.T. & Nelson, E., 1998. "Nominal Income Targeting in an Open-Economy Optimizing Model," Papers 644, Stockholm - International Economic Studies.
    12. 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.
    13. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
    14. 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.
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