Monetary Policy and its Informative Value

Camille Cornand and Romain Baeriswyl

FMG Discussion Papers from Financial Markets Group

Abstract: This paper analyzes the welfare effects of economic transparency in the conduct of monetary policy. We propose a model of monopolistic competition with imperfect common knowledge on the shocks affecting the economy where the central bank has no inflationary bias. In this context, monetary policy entails a dual role. The instrument of the central bank is both an action that stabilizes the economy and a public signal that partially reveals to firms the central bank's assessment about the state of the economy. Yet, firms are unable toperfectly disentangle the central bank's signals responsible for the instrument and the central bank optimally balances the action and information purposes of its instrument. We derive the optimal monetary policy and the optimal central bank's disclosure. We define transparency as an announcement by the central bank that allows firms to identify the rationale behind the instrument. It turnsout that transparency is welfare increasing (i) when the degree of strategic complementarities is low, (ii) when the economy is not too affected by mark-up shocks, (iii) when the central bank is more inclined towards price stabilization, (iv) when firms have relatively precise private information, and (v) when the central bank's information is relatively precise on demand shocks and relatively imprecise on mark-up shocks. These results rationalize the increase in trans-parency in the current context of relative low sensitivity of the economy to mark-up shocks and of strong central bank's preference for price stability.JEL classification: E52, E58, D82.Keywords: differential information, monetary policy, transparency.

Date: 2006-07
New Economics Papers: this item is included in nep-cba, nep-mac and nep-mon
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Journal Article: Monetary policy and its informative value (2007)
Working Paper: Monetary policy and its informative value (2006)
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