Observing and Shaping the Market: The Dilemma of Central Banks
29 Pages Posted: 2 Jul 2016 Last revised: 21 Feb 2018
Date Written: February 2018
While the central bank observes the market activity to assess economic fundamentals, it shapes the market outcome through its policy interventions. The more the central bank influences the market, the more it spoils the informational content of economic aggregates. How should the central bank act and communicate when it derives its information from observing the market? This paper analyses the optimal central bank’s action and disclosure under endogenous central bank’s information for three operational frameworks: pure communication, action and communication, and signaling action. When the central bank takes an action, it would be optimal for the central bank to be fully opaque to prevent its disclosure from deteriorating the information quality of market outcomes. However, in the realistic case where central bank’s action is observable, it may be optimal to refrain from implementing any action.
Keywords: heterogeneous information, public information, endogenous information, overreaction, transparency, coordination
JEL Classification: D82, E52, E58
Suggested Citation: Suggested Citation