Interest Rate Signals and Central Bank Transparency

35 Pages Posted: 30 May 2008

See all articles by Pierre Gosselin

Pierre Gosselin

University of Geneva - Graduate Institute of International Studies (HEI)

Aileen Gosselin-Lotz

University of Geneva - Graduate Institute of International Studies (HEI)

Charles Wyplosz

University of Geneva - Graduate Institute of International Studies (HEI); Centre for Economic Policy Research (CEPR)

Date Written: September 2007

Abstract

The present paper extends the literature on central bank transparency that relies on information heterogeneity among private agents in four directions. First, it adds the interest rate to the list of signals that the central bank can reveal. Second, it allows for more than one economic fundamental. Third, it extends the range of uncertainties that matter. So far the literature has focused on uncertainty about the economic fundamentals, assumed to be estimated with known precision; we also allow for uncertainty about precision. Fourth, it derives results that are general in the sense that they do not depend on any particular social welfare criterion. Each extension sheds new light on the role of central bank transparency.

Focusing on the signaling role of the interest rate, we consider various degrees of transparency, ranging from full opacity, to just publishing the interest rate, to also revealing the signals and estimates of their precision.

While uncertainty about the fundamentals results in the now familiar common knowledge effect, uncertainty about information precision creates a fog effect, which reduces the quality of decisions taken by the central bank and the private sector. In the absence of the fog effect, full transparency is generally not desirable, because it deprives the central bank from the ability to optimally manipulate private sector expectations. When the central bank's fog is large, we find that full transparency is usually the best communication strategy. This result tends to survive when the private sector's fog is large. Full opacity is only desirable when the central bank is poorly informed.

Another result that emerges from our analysis is that it is usually desirable for the central bank to divulge some information, even if it is erroneous, and known to be erroneous. The reason is that, when the private sector knows that the central bank is mistaken, it needs to evaluate the extent of its mistakes.

Keywords: central bank transparency, information asymmetry, monetary policy

JEL Classification: E42, E52, E58

Suggested Citation

Gosselin, Pierre and Gosselin-Lotz, Aileen and Wyplosz, Charles, Interest Rate Signals and Central Bank Transparency (September 2007). Available at SSRN: https://ssrn.com/abstract=1138567

Pierre Gosselin

University of Geneva - Graduate Institute of International Studies (HEI) ( email )

PO Box 136
Geneva, CH-1211
Switzerland
+41 22 908 5926 (Phone)
+41 22 733 3049 (Fax)

Aileen Gosselin-Lotz

University of Geneva - Graduate Institute of International Studies (HEI) ( email )

PO Box 136
Geneva, CH-1211
Switzerland

Charles Wyplosz (Contact Author)

University of Geneva - Graduate Institute of International Studies (HEI) ( email )

PO Box 136
Geneva, CH-1211
Switzerland
+41 22 908 5946 (Phone)
+41 22 733 3049 (Fax)

HOME PAGE: http://heiwww.unige.ch/~wyplosz

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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