IDEAS home Printed from https://ideas.repec.org/p/pen/papers/13-041.html
   My bibliography  Save this paper

Constrained Discretion and Central Bank Transparency

Author

Listed:
  • Francesco Bianchi

    () (Department of Economics, Duke University)

  • Leonardo Melosi

    () (Federal Reserve Bank of Chicago)

Abstract

We develop a theoretical framework to quantitatively assess the general equilibrium effects and welfare implications of central bank reputation and transparency. Monetary policy alternates between periods of active inflation stabilization and periods during which the emphasis on inflation stabilization is reduced. When the central bank only engages in short deviations from active monetary policy, inflation expectations remain anchored and the model captures the monetary approach described as constrained discretion. However, if the central bank deviates for a prolonged period of time, agents gradually become pessimistic about future monetary policy, the disanchoring of inflation expectations occurs, and uncertainty rises. Reputation determines the speed with which agents’' pessimism accelerates once the central bank starts deviating. When the model is fitted to U.S. data, we find that the Federal Reserve can accommodate contractionary technology shocks for up to five years before inflation expectations take off. Increasing transparency would improve welfare by anchoring agents’ expectations. Gains from transparency are even more sizeable for countries whose central banks have weak reputation

Suggested Citation

  • Francesco Bianchi & Leonardo Melosi, 2012. "Constrained Discretion and Central Bank Transparency," PIER Working Paper Archive 13-041, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  • Handle: RePEc:pen:papers:13-041
    as

    Download full text from publisher

    File URL: https://economics.sas.upenn.edu/sites/default/files/filevault/13-041.pdf
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Francesco Bianchi & Leonardo Melosi, 2017. "Escaping the Great Recession," American Economic Review, American Economic Association, vol. 107(4), pages 1030-1058, April.
    2. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 101-121.
    3. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," The Quarterly Journal of Economics, Oxford University Press, vol. 115(1), pages 147-180.
    4. Francesco Bianchi & Leonardo Melosi, 2016. "Modeling The Evolution Of Expectations And Uncertainty In General Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 57, pages 717-756, May.
    5. Marcet, Albert & Sargent, Thomas J., 1989. "Convergence of least squares learning mechanisms in self-referential linear stochastic models," Journal of Economic Theory, Elsevier, vol. 48(2), pages 337-368, August.
    6. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," Review of Economic Studies, Oxford University Press, vol. 79(4), pages 1371-1406.
    7. Bartosz Mackowiak & Mirko Wiederholt, 2009. "Optimal Sticky Prices under Rational Inattention," American Economic Review, American Economic Association, vol. 99(3), pages 769-803, June.
    8. Yuriy Gorodnichenko, 2008. "Endogenous information, menu costs and inflation persistence," NBER Working Papers 14184, National Bureau of Economic Research, Inc.
    9. Del Negro, Marco & Eusepi, Stefano, 2011. "Fitting observed inflation expectations," Journal of Economic Dynamics and Control, Elsevier, vol. 35(12), pages 2105-2131.
    10. Thomas A. Lubik & Frank Schorfheide, 2004. "Testing for Indeterminacy: An Application to U.S. Monetary Policy," American Economic Review, American Economic Association, vol. 94(1), pages 190-217, March.
    11. Christian Matthes & Argia M. Sbordone & Timothy Cogley, 2011. "Optimal Disinflation Under Learning," 2011 Meeting Papers 74, Society for Economic Dynamics.
    12. Charles I. Plosser, 2012. "Economic outlook and the limits of monetary policy," Speech 73, Federal Reserve Bank of Philadelphia.
    13. Ríos-Rull, José-Víctor & Schorfheide, Frank & Fuentes-Albero, Cristina & Kryshko, Maxym & Santaeulàlia-Llopis, Raül, 2012. "Methods versus substance: Measuring the effects of technology shocks," Journal of Monetary Economics, Elsevier, vol. 59(8), pages 826-846.
    14. Frank Schorfheide, 2005. "Learning and Monetary Policy Shifts," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 392-419, April.
    15. Francesco Bianchi & Leonardo Melosi, 2014. "Dormant Shocks and Fiscal Virtue," NBER Macroeconomics Annual, University of Chicago Press, vol. 28(1), pages 1-46.
    16. Jordi Galí, 2008. "Introduction to Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework," Introductory Chapters,in: Monetary Policy, Inflation, and the Business Cycle: An Introduction to the New Keynesian Framework Princeton University Press.
    17. Timothy Cogley & Thomas J. Sargent, 2005. "Drift and Volatilities: Monetary Policies and Outcomes in the Post WWII U.S," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 262-302, April.
    18. Francesco Bianchi, 2013. "Regime Switches, Agents' Beliefs, and Post-World War II U.S. Macroeconomic Dynamics," Review of Economic Studies, Oxford University Press, vol. 80(2), pages 463-490.
    19. 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.
    20. Tao Zha & Juan F. Rubio-Ramirez & Daniel F. Waggoner & Andrew T. Foerster, 2010. "Perturbation Methods for Markov-Switching Models," 2010 Meeting Papers 239, Society for Economic Dynamics.
    21. Charles I. Plosser, 2012. "Economic outlook and monetary policy," Speech 72, Federal Reserve Bank of Philadelphia.
    22. Olivier Coibion & Yuriy Gorodnichenko & Johannes Wieland, 2012. "The Optimal Inflation Rate in New Keynesian Models: Should Central Banks Raise Their Inflation Targets in Light of the Zero Lower Bound?," Review of Economic Studies, Oxford University Press, vol. 79(4), pages 1371-1406.
    23. repec:oup:restud:v:84:y:2017:i:2:p:853-884. is not listed on IDEAS
    24. 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 369-397, May.
    25. Steinsson, Jon, 2003. "Optimal monetary policy in an economy with inflation persistence," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1425-1456, October.
    26. Castelnuovo, Efrem & Nicoletti-Altimari, Sergio & Rodriguez-Palenzuela, Diego, 2003. "Definition of price stability, range and point inflation targets: the anchoring of long-term inflation expectations," Working Paper Series 273, European Central Bank.
    27. George W. Evans & Seppo Honkapohja, 2003. "Expectations and the Stability Problem for Optimal Monetary Policies," Review of Economic Studies, Oxford University Press, vol. 70(4), pages 807-824.
    28. Troy Davig & Eric M. Leeper, 2007. "Generalizing the Taylor Principle," American Economic Review, American Economic Association, vol. 97(3), pages 607-635, June.
    29. Schmitt-Grohe, Stephanie & Uribe, Martin, 2007. "Optimal simple and implementable monetary and fiscal rules," Journal of Monetary Economics, Elsevier, vol. 54(6), pages 1702-1725, September.
    30. Farmer, Roger E.A. & Waggoner, Daniel F. & Zha, Tao, 2009. "Understanding Markov-switching rational expectations models," Journal of Economic Theory, Elsevier, vol. 144(5), pages 1849-1867, September.
    31. Charles I. Plosser, 2012. "Economic outlook and communicating monetary policy," Speech 61, Federal Reserve Bank of Philadelphia.
    32. Jeffrey R. Campbell & Jonas D. M. Fisher & Alejandro Justiniano & Leonardo Melosi, 2017. "Forward Guidance and Macroeconomic Outcomes since the Financial Crisis," NBER Macroeconomics Annual, University of Chicago Press, vol. 31(1), pages 283-357.
    33. repec:fip:fedpsp:y:2012:i:october11 is not listed on IDEAS
    34. Troy Davig & Taeyoung Doh, 2014. "Monetary Policy Regime Shifts and Inflation Persistence," The Review of Economics and Statistics, MIT Press, vol. 96(5), pages 862-875, December.
    35. Giorgio E. Primiceri, 2005. "Time Varying Structural Vector Autoregressions and Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 821-852.
    36. Ben S. Bernanke & Frederic S. Mishkin, 1997. "Inflation Targeting: A New Framework for Monetary Policy?," Journal of Economic Perspectives, American Economic Association, vol. 11(2), pages 97-116, Spring.
    37. Rotemberg, Julio J. & Woodford, Michael, 1999. "The cyclical behavior of prices and costs," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 16, pages 1051-1135 Elsevier.
    38. Andrew Foerster & Juan F. Rubio‐Ramírez & Daniel F. Waggoner & Tao Zha, 2016. "Perturbation methods for Markov‐switching dynamic stochastic general equilibrium models," Quantitative Economics, Econometric Society, vol. 7(2), pages 637-669, July.
    39. Nimark, Kristoffer, 2008. "Dynamic pricing and imperfect common knowledge," Journal of Monetary Economics, Elsevier, vol. 55(2), pages 365-382, March.
    40. Marcet, Albert & Sargent, Thomas J, 1989. "Convergence of Least-Squares Learning in Environments with Hidden State Variables and Private Information," Journal of Political Economy, University of Chicago Press, vol. 97(6), pages 1306-1322, December.
    41. Christopher A. Sims & Tao Zha, 2006. "Were There Regime Switches in U.S. Monetary Policy?," American Economic Review, American Economic Association, vol. 96(1), pages 54-81, March.
    42. Faia, Ester & Monacelli, Tommaso, 2007. "Optimal interest rate rules, asset prices, and credit frictions," Journal of Economic Dynamics and Control, Elsevier, vol. 31(10), pages 3228-3254, October.
    43. Leonardo Melosi, 2017. "Signalling Effects of Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 84(2), pages 853-884.
    44. Leonardo Melosi, 2014. "Estimating Models with Dispersed Information," American Economic Journal: Macroeconomics, American Economic Association, vol. 6(1), pages 1-31, January.
    45. 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 473-491, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Francesco Bianchi & Cosmin Ilut, 2017. "Monetary/Fiscal Policy Mix and Agent's Beliefs," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 26, pages 113-139, October.
    2. repec:aea:aejmac:v:11:y:2019:i:3:p:1-29 is not listed on IDEAS
    3. Francesco Bianchi & Leonardo Melosi, 2016. "Modeling The Evolution Of Expectations And Uncertainty In General Equilibrium," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 57, pages 717-756, May.
    4. repec:bfr:rueban:2017:48 is not listed on IDEAS
    5. Leonardo Melosi, 2014. "Signaling Effects of Monteray Policy," 2014 Meeting Papers 830, Society for Economic Dynamics.
    6. Michael Ehrmann, 2015. "Targeting Inflation from Below: How Do Inflation Expectations Behave?," International Journal of Central Banking, International Journal of Central Banking, vol. 11(4), pages 213-249, September.
    7. Philippe Andrade & Gaetano Gaballo & Eric Mengus & Benoît Mojon, 2019. "Forward Guidance and Heterogeneous Beliefs," American Economic Journal: Macroeconomics, American Economic Association, vol. 11(3), pages 1-29, July.
    8. Stephen Hansen & Michael McMahon, 2016. "First Impressions Matter: Signalling as a Source of Policy Dynamics," Review of Economic Studies, Oxford University Press, vol. 83(4), pages 1645-1672.
    9. repec:oup:restud:v:84:y:2017:i:2:p:853-884. is not listed on IDEAS
    10. Fujiwara, Ippei & Waki, Yuichiro, 2015. "Private news and monetary policy forward guidance or (the expected virtue of ignorance)," Globalization Institute Working Papers 238, Federal Reserve Bank of Dallas.
    11. Francesco Bianchi & Leonardo Melosi, 2014. "Dormant Shocks and Fiscal Virtue," NBER Macroeconomics Annual, University of Chicago Press, vol. 28(1), pages 1-46.
    12. Istrefi, Klodiana & Mouabbi, Sarah, 2018. "Subjective interest rate uncertainty and the macroeconomy: A cross-country analysis," Journal of International Money and Finance, Elsevier, vol. 88(C), pages 296-313.
    13. Christian Matthes, 2015. "Figuring Out the Fed—Beliefs about Policymakers and Gains from Transparency," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 47(1), pages 1-29, February.
    14. Leonardo Melosi, 2017. "Signalling Effects of Monetary Policy," Review of Economic Studies, Oxford University Press, vol. 84(2), pages 853-884.
    15. K. Istrefi & A. Piloiu, 2016. "Economic policy uncertainty and inflation expectations," Rue de la Banque, Banque de France, issue 33, november..
    16. Bianchi, Francesco, 2016. "Methods for measuring expectations and uncertainty in Markov-switching models," Journal of Econometrics, Elsevier, vol. 190(1), pages 79-99.
    17. Ehrmann, Michael & Gaballo, Gaetano & Hoffmann, Peter & Strasser, Georg, 2019. "Can more public information raise uncertainty? The international evidence on forward guidance," Working Paper Series 2263, European Central Bank.
    18. Grégory Levieuge & Yannick Lucotte & Florian Pradines-Jobet, 2019. "The Cost of Banking Crises: Does the Policy Framework Matter?," Working papers 712, Banque de France.

    More about this item

    Keywords

    Bayesian learning; reputation; uncertainty; inflation expectations; Markov-switching models; impulse response;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pen:papers:13-041. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Administrator). General contact details of provider: http://edirc.repec.org/data/deupaus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.