nr 003 - Central Bank Communication and Output Stabilization

DNB Working Papers
Date 26 July 2004
Some central banks have a reputation for being secretive. A justification for that behavior that we find in the literature is that being transparent about its operations and beliefs hinders the central bank in achieving the best outcome. In other words, a central bank needs flexibility and therefore cannot be fully transparent. Using a forward-looking New-Keynesian model, we find exactly the opposite. A central bank that is conservative improves output stabilization by being transparent about the procedures it uses to assess the economy and, especially, about the forecast errors it makes. Under certain conditions transparency by a conservative central bank also improves interest rate stabilization. We also find that higher transparency makes it optimal for the central bank to be more conservative as the benefits from higher transparency in terms of output stabilization are greater the more conservative the central bank is. Key words: monetary policy, central bank, information processing, expectation formation JEL codes: D83, E52, E58