Working Paper: CEPR ID: DP4408
Authors: Sylvester C. W. Eijffinger; Marco M. Hoeberichts; Mewael F. Tesfaselassie
Abstract: Some central banks have a reputation for being secretive. A justification for this behaviour that we find in the literature is that being transparent about operations and beliefs hinders the central bank in achieving the best outcome. In other words, a central bank needs flexibility and therefore cannot be fully transparent. Using a forward-looking New-Keynesian model, we find exactly the opposite. A central bank that is conservative improves output stabilization by being transparent about the procedures it uses to assess the economy and, especially, about the forecast errors it makes. Under certain conditions transparency by a conservative central bank also improves interest rate stabilization. We also find that higher transparency makes it optimal for the central bank to be more conservative as the benefits from higher transparency in terms of output stabilization are greater the more conservative the central bank is.
Keywords: central bank; expectation formation; information processing; monetary policy
JEL Codes: D83; E52; E58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| communication about assessment errors (C83) | volatility of inflation (E31) |
| communication about assessment errors (C83) | volatility of output gap (E32) |
| better communication (L96) | more accurate expectations (D84) |
| more accurate expectations (D84) | improved policy responses by the central bank (E52) |
| central bank communication (E58) | output stabilization (E63) |
| conservative central bank (E58) | enhanced output stabilization (E63) |