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Central bank communication and expectations stabilization

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Author Info
Stefano Eusepi
Bruce Preston

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Abstract

This paper analyzes the value of communication in the implementation of monetary policy. The central bank is uncertain about the current state of the economy. Households and firms do not have a complete economic model of the determination of aggregate variables, including nominal interest rates, and must learn about their dynamics using historical data. When the central bank implements optimal policy, the Taylor principle is not sufficient for macroeconomic stability: for all reasonable parameterizations self-fulfilling expectations are possible. To mitigate this instability, three communication strategies are contemplated: i) communicating the precise details of the monetary policy -- that is, the variables and coefficients; ii) communicating just the variables on which monetary policy decisions are conditioned; and iii) communicating the inflation target. The first two strategies restore the Taylor principle as a sufficient condition for stabilizing expectations. In contrast, in economies with persistent shocks, communicating the inflation target fails to protect against expectations driven fluctuations. These results underscore the importance of communicating the systematic component of current and future monetary policy decisions: announcing an inflation target is not enough to stabilize expectations -- one must also announce how this target will be achieved.

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Article provided by Federal Reserve Bank of San Francisco in its journal Proceedings.

Volume (Year): (2007)
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Handle: RePEc:fip:fedfpr:y:2007:x:1

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Related research
Keywords: Monetary policy;

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Cited by:
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  1. Stefano Eusepi, 2008. "Central bank transparency and nonlinear learning dynamics," Staff Reports 342, Federal Reserve Bank of New York. [Downloadable!]
  2. George Evans & Seppo Honkapohja & Kaushik Mitra, 2007. " Anticipated Fiscal Policy and Adaptive Learning," CDMA Working Paper Series 0717, Centre for Dynamic Macroeconomic Analysis. [Downloadable!]
    Other versions:
  3. Alan S. Blinder & Michael Ehrmann & Marcel Fratzscher & Jakob de Haan & David-Jan Jansen, 2008. "Central Bank Communication and Monetary Policy: A Survey of Theory and Evidence," DNB Working Papers 170, Netherlands Central Bank, Research Department. [Downloadable!]
    Other versions:
  4. Katerina Smidkova, 2008. "Evaluation of the Fulfilment of the CNB's Inflation Targets," Occasional Publications - Chapters in Edited Volumes, in: Katerina Smidkova (ed.), Evaluation of the Fulfilment of the CNB's Inflation Targets 1998-2007, chapter 1, pages 10-17 Czech National Bank, Research Department. [Downloadable!]
  5. Brzoza-Brzezina, Michal & Kot, Adam, 2008. "The Relativity Theory Revisited: Is Publishing Interest Rate Forecasts Really so Valuable?," MPRA Paper 10296, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  6. Evans , George W & Honkapohja, Seppo, 2007. "Expectations, learning and monetary policy: an overview of recent research," Research Discussion Papers 32/2007, Bank of Finland. [Downloadable!]
    Other versions:
  7. Hughes Hallett Andrew & Di Bartolomeo Giovanni & Acocella Nicola, 2008. "Controllability under rational expectations," wp.comunite 0042, Department of Communication, University of Teramo. [Downloadable!]
  8. James B. Bullard & Stefano Eusepi, 2009. "When does determinacy imply expectational stability?," Working Papers 2008-007, Federal Reserve Bank of St. Louis. [Downloadable!]
  9. Acocella, Nicola & Di Bartolomeo, Giovanni & Hughes Hallett, Andrew, 2008. "When Can Central Banks Anchor Expectations? Policy communication and controllability," CEPR Discussion Papers 7078, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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