Constrained Discretion and Central Bank Transparency

Francesco Bianchi and Leonardo Melosi

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

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 only engages in 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 gradually become pessimistic about future monetary policy, the disanchoring of inflation expectations occurs, and uncertainty 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, we find that the Federal Reserve can accommodate contractionary technology shocks for up to five years before inflation expectations take off. Increasing transparency would improve welfare by anchoring agents’ expectations. Gains from transparency are even more sizeable for countries whose central banks have weak reputation.

Keywords: Bayesian learning; reputation; uncertainty; in.ation expectations; Markov-switching models; impulse response (search for similar items in EconPapers)
JEL-codes: C11 D83 E52 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2012-10-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (11)

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Related works:
Journal Article: Constrained Discretion and Central Bank Transparency (2018)
Working Paper: Constrained Discretion and Central Bank Transparency (2016)
Working Paper: Constrained Discretion and Central Bank Transparency (2014)
Working Paper: Constrained Discretion and Central Bank Transparency (2014)
Working Paper: Constrained Discretion and Central Bank Transparency (2014)
Working Paper: Constrained Discretion and Central Bank Transparency (2014)
Working Paper: Constrained Discretion and Central Bank Transparency (2013)
Working Paper: Constrained Discretion and Central Bank Transparency (2012)
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