Transparency and Credibility: Monetary Policy with Unobservable Goals

43 Pages Posted: 12 Oct 2010 Last revised: 20 Aug 2022

See all articles by Jon Faust

Jon Faust

Board of Governors of the Federal Reserve System

Lars E. O. Svensson

Stockholm School of Economics; Stockholm University - Institute for International Economic Studies (IIES); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

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Date Written: March 1998

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 are inferred from the policy outcome. A low-credibility bank optimally conducts a more inflationary policy than a high-credibility bank, in the sense that it induces higher inflation, but a less expansionary policy in the sense that it induces lower inflation and employment than expected. Increased transparency makes the bank's reputation and credibility more sensitive to its actions. This has a moderating influence on the bank's policy. Full transparency of the central bank's intentions is generally socially beneficial, but frequently not in the interest of the bank. Somewhat paradoxically, direct observability of idiosyncratic central bank goals removes the moderating incentive on the bank and leads to the worst equilibrium.

Suggested Citation

Faust, Jon and Svensson, Lars E.O., Transparency and Credibility: Monetary Policy with Unobservable Goals (March 1998). NBER Working Paper No. w6452, Available at SSRN: https://ssrn.com/abstract=1689382

Jon Faust (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Lars E.O. Svensson

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Stockholm University - Institute for International Economic Studies (IIES) ( email )

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Centre for Economic Policy Research (CEPR)

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