Scandinavian Working Papers in Economics

Seminar Papers,
Stockholm University, Institute for International Economic Studies

No 636: Transparency and Credibility: Monetary Policy with Unobservable Goals

Lars E.O. Svensson () and John Faust ()
Additional contact information
Lars E.O. Svensson: Institute for International Economic Studies, Stockholm University, Postal: Stockholm University, S-106 69 Stockholm, Sweden
John Faust: Board of Governors of the Federal Reserve System

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: Monetary Policy; transparency; credibility

JEL-codes: E50; E52

40 pages, February 26, 1998

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