IDEAS home Printed from https://ideas.repec.org/p/van/wpaper/0404.html
   My bibliography  Save this paper

Rational Ambiguity and Monitoring the Central Bank

Author

Listed:
  • Maria Demertzis

    (De Nederlandsche Bank)

  • Andrew Hughes Hallett

    (Vanderbilt University and CEPR)

Abstract

In this paper we examine the consequences of having a Central Bank whose preferences are state contingent. This has variously been identified in the literature as a Central Bank that is "rationally inattentive", "risk averse", or "constructively ambiguous". The new feature in this paper is that we show how the private sector is likely to react. There are two possibilities: the public can form rational expectations and internalize the uncertainty about the Bank's preferences in full. Alternatively, and particularly if the process of internalization is costly, it can form a best guess regarding those preferences. This latter case implies a strategy of certainty equivalence. We examine the magnitude of the resulting error in inflation and output if the certainty equivalence approximation is used. Under all reasonable levels of uncertainty, the error turns out to be small. In that case, the certainty equivalence strategy would be "rational". But it involves trading off accepting a deflation bias against the cost of gathering the information needed to calculate the full rational expectations solution.

Suggested Citation

  • Maria Demertzis & Andrew Hughes Hallett, 2004. "Rational Ambiguity and Monitoring the Central Bank," Vanderbilt University Department of Economics Working Papers 0404, Vanderbilt University Department of Economics.
  • Handle: RePEc:van:wpaper:0404
    as

    Download full text from publisher

    File URL: http://www.accessecon.com/pubs/VUECON/vu04-w04.pdf
    File Function: First version, 2004
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Faust, Jon & Svensson, Lars E O, 2002. "The Equilibrium Degree of Transparency and Control in Monetary Policy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(2), pages 520-539, May.
    2. Hughes Hallett, A. J., 1979. "Computing revealed preferences and limits to the validity of quadratic objective functions for policy optimization," Economics Letters, Elsevier, vol. 2(1), pages 27-32.
    3. Demertzis, Maria & Hughes Hallett, Andrew, 2007. "Central Bank transparency in theory and practice," Journal of Macroeconomics, Elsevier, pages 760-789.
    4. Lars Peter Hansen & Thomas J. Sargent & Thomas D. Tallarini, 1999. "Robust Permanent Income and Pricing," Review of Economic Studies, Oxford University Press, vol. 66(4), pages 873-907.
    5. Walsh, Carl E, 1999. "Announcements, Inflation Targeting and Central Bank Incentives," Economica, London School of Economics and Political Science, vol. 66(262), pages 255-269, May.
    6. Otmar Issing, 1999. "The Eurosystem: Transparent andAccountable or 'Willem in Euroland'," Journal of Common Market Studies, Wiley Blackwell, vol. 37(3), pages 503-519, September.
    7. 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.
    8. Sibert, Anne, 2002. "Monetary policy with uncertain central bank preferences," European Economic Review, Elsevier, vol. 46(6), pages 1093-1109, June.
    9. Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-334, June.
    10. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
    11. Muscatelli, Anton, 1998. "Optimal Inflation Contracts and Inflation Targets with Uncertain Central Bank Preferences: Accountability through Independence?," Economic Journal, Royal Economic Society, vol. 108(447), pages 529-542, March.
    12. Jordi Galí & Tommaso Monacelli, 2005. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 707-734.
    13. Demertzis, Maria & Hughes Hallett, Andrew, 2003. "Three Models of Imperfect Transparency in Monetary Policy," CEPR Discussion Papers 4117, C.E.P.R. Discussion Papers.
    14. Kenneth Rogoff, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, Oxford University Press, vol. 100(4), pages 1169-1189.
    15. Julio J. Rotemberg & Michael Woodford, 1998. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy: Expanded Version," NBER Technical Working Papers 0233, National Bureau of Economic Research, Inc.
    16. 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.
    17. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
    18. Hallett, A. J. Hughes, 1984. "Optimal stockpiling in a high-risk commodity market the case of copper," Journal of Economic Dynamics and Control, Elsevier, vol. 8(2), pages 211-238, November.
    19. Hughes Hallett, A. J., 1984. "On alternative methods of generating risk sensitive decision rules," Economics Letters, Elsevier, vol. 16(1-2), pages 37-44.
    20. Petra M. Geraats, 2002. "Central Bank Transparency," Economic Journal, Royal Economic Society, vol. 112(483), pages 532-565, November.
    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. Buigut, Steven & Valev, Neven T., 2009. "Benefits from Mutual Restraint in a Multilateral Monetary Union," World Development, Elsevier, vol. 37(3), pages 585-594, March.

    More about this item

    Keywords

    Central Bank Transparency; Certainty Equivalence; Rational Expectatatins; Ambiguity and Rational Inattention;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

    NEP fields

    This paper has been announced in the following NEP Reports:

    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:van:wpaper:0404. 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: (John P. Conley). General contact details of provider: http://www.vanderbilt.edu/econ/wparchive/index.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.