Working Paper: CEPR ID: DP9955
Authors: Francesco Bianchi; Leonardo Melosi
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 engages in only 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 become pessimistic about future monetary policy and uncertainty gradually 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, the Federal Reserve is found to benefit from strong reputation and large flexibility in responding to inflationary shocks. Increasing transparency would improve welfare by anchoring agents' expectations.
Keywords: Bayesian learning; Inflation expectations; Markov-switching models; Reputation; Uncertainty
JEL Codes: C11; D83; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Lack of transparency (D82) | Increased uncertainty (D89) |
| Transparency (G38) | More accurate expectations about future monetary policy (E49) |
| Central bank's reputation (E58) | Speed of agents' pessimism acceleration (D84) |
| Length of deviation from active inflation stabilization (E63) | Pessimism about future monetary policy (E66) |
| Length of deviation from active inflation stabilization (E63) | Welfare losses (D69) |
| Transparency (G38) | Reduced uncertainty (D80) |
| Transparency (G38) | Improved welfare (I39) |
| Transparency (G38) | Anchoring agents' expectations (D84) |
| Central bank's reputation (E58) | Mitigation of adverse effects of prolonged passive policies (E63) |
| Transparency of policy announcements (E60) | Stabilization of inflation expectations (E31) |