Working Paper: CEPR ID: DP1852
Authors: Jon Faust; Lars E.O. Svensson
Abstract: We define and study transparency, credibility and reputation in a model where the central bank?s characteristics are unobservable to the private sector and are inferred from the policy outcome. A low-credibility bank optimally conducts a more inflationary policy than a high-credibility bank, in the sense that it induces higher inflation, but a less expansionary policy, in the sense that it induces lower inflation and employment than expected. Increased transparency makes the bank?s reputation and credibility more sensitive to its actions. This has a moderating influence on the bank?s policy. Full transparency of the central bank?s intentions is generally socially beneficial, but frequently not in the interest of the bank. Somewhat paradoxically, direct observability of idiosyncratic central bank goals removes the moderating incentive on the bank and leads to the worst equilibrium.
Keywords: reputation; time consistency
JEL Codes: E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Low-credibility bank (G21) | Higher inflation (E31) |
| Low-credibility bank (G21) | Lower employment (J63) |
| Increased transparency (G38) | Higher sensitivity of bank's reputation to its actions (G21) |
| Increased transparency (G38) | Lower inflation bias (E31) |
| Increased transparency (G38) | Reduced variability in inflation and employment (E39) |
| Increased transparency (G38) | Enhanced social welfare (D69) |
| Extreme transparency (G38) | High inflation bias (E31) |
| Increased transparency (G38) | Potential conflicts between social preferences and bank's policy decisions (G21) |