Expectations and the Central Banker: Making Decisions the Market Expects to See?

Tufts University Economics Working Paper

28 Pages Posted: 15 Apr 2004

See all articles by Edward Kutsoati

Edward Kutsoati

Tufts University - Department of Economics

Sharun Mukand

Tufts University - Department of Economics

Date Written: June 26, 2004

Abstract

This paper develops a simple model to examine conditions under which a monetary policymaking authority is tempted to follow the market. In doing so, we explore the implications of increased market-consensus on the practice of monetary policy and show that inefficiency in policymaking is most likely precisely when there is a very high consensus that economic fundamentals are weak or strong. In addition, our results also shed light on (i) why interest rates may not be high enough even when the central bank's information suggests a rise in asset prices may be due to `bubble' shock; (ii) why a central banker may be reluctant to adopt a loose monetary policy even when investors seem to be very pessimistic about the path of future output; and (iii) why, contrary to conventional models, we sometimes observe an upward revision of private sector's forecasts of inflation when the central bank tightens its monetary policy. The results have implications for transparency of monetary policy.

Keywords: Asymmetric information, monetary policy, transparency

JEL Classification: D82, E44, E52, E58

Suggested Citation

Kutsoati, Edward and Mukand, Sharun, Expectations and the Central Banker: Making Decisions the Market Expects to See? (June 26, 2004). Tufts University Economics Working Paper, Available at SSRN: https://ssrn.com/abstract=530342 or http://dx.doi.org/10.2139/ssrn.530342

Edward Kutsoati (Contact Author)

Tufts University - Department of Economics ( email )

Medford, MA 02155
United States
617-627-2688 (Phone)
617-627-3917 (Fax)

Sharun Mukand

Tufts University - Department of Economics ( email )

Medford, MA 02155
United States
617-627-5476 (Phone)
617-627-3917 (Fax)