Money Talks

Abstract

We study credible information transmission by a benevolent short-lived central bank. We consider two possibilities: direct revelation through an announcement, versus indirect transmission through monetary policy. We show that, in the presence of externalities creating a wedge between private and social welfare, the central bank prefers to mis-report its information in some cases. Private investors then might rationally ignore announcements by the central bank. In contrast, information transmission through changes in the interest rate creates a distortion, thus lending an amount of credibility. This induces private investors to rationally take into account information revealed through monetary policy.

Keywords: Information, Interest rates, Monetary policy

JEL Classification: D80, E40, E52