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Central bank transparency with the cost channel

  • Meixing Dai
  • Qiao Zhang

Using a New Keynesian model with the cost channel, characterized by distortions due to monopolistic competition and the firms’ need to pre-finance their production, we show that central bank transparency affects the economy not only through the effects of inflation shocks but also of demand shocks. The economy is affected by opacity in the same way, but with smaller amplitude, in the case of demand shocks than in the case of inflation shocks except when the latter have a significantly lower variance. Generally, imperfect transparency could discipline the price-setting behavior of firms by reducing the average reaction of inflation to inflation and demand shocks and hence the volatility of inflation while increasing these of the output gap, and more so when these shocks are highly persistent. It could thus significantly improve social welfare if the society assigns a very low weight to output-gap stabilization. The presence of the cost channel reinforces significantly the effects of opacity on the responses of endogenous variables and their volatility to inflation shocks.

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Paper provided by Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg in its series Working Papers of BETA with number 2013-06.

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Date of creation: 2013
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Handle: RePEc:ulp:sbbeta:2013-06
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