Jon Faust

Transparency and Credibility: Monetary Policy with Unobservable Goals

Authors: Faust, Jon; Svensson, Lars E. O.

Source: International Economic Review, May 2001, v. 42, iss. 2, pp. 369-97

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 inferred from the policy outcome. Increased transparency makes the bank's reputation and credibility more sensitive to its actions. This moderates the bank's policy and induces the bank to follow a policy closer to the socially optimal one. Full transparency of the central bank's intentions is generally socially beneficial but frequently worse for the bank. Somewhat paradoxically, direct observability of idiosyncratic central bank goals removes the moderating influence on the bank and leads to the worst equilibrium.

Descriptors: Monetary Policy (Targets, Instruments, and Effects) (E520) Central Banks and Their Policies (organization, case studies, lender of last resort issues) (E580)

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