Central bank communication and multiple equilibria

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Abstract

In this paper, we construct a simple model for communication between a central bank and money-market traders. It is demonstrated that there are multiple equilibria. In one equilibrium, traders truthfully reveal their own information, and by learning this, the central bank can make better forecasts. Another equilibrium is a "dog-chasing-its-tail" equilibrium described by Blinder (1998). Traders mimic the central bank's forecast, so the central bank simply observes its own forecast from traders. The latter equilibrium is socially worse, as inflation variability becomes larger. As policy implications, we find that too-high transparency of central banks is bad because it yields the "dog-chasing-its-tail" equilibrium, and central banks should conduct continuous monitoring or emphasize that their forecasts are conditional because doing so eliminates the "dog-chasing-its-tail" equilibrium. We also consider the possibility of the existence of an optimal degree of transparency.

Original languageEnglish
Pages (from-to)145-167
Number of pages23
JournalInternational Journal of Central Banking
Volume6
Issue number3
Publication statusPublished - 2010 Sep
Externally publishedYes

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ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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