The Costs of Increasing Transparency

In their seminal paper, Morris and Shin (Amer Econ Rev 92(5): 1521–1534, 2002a ) argued that increasing the precision of public information is not always beneficial to social welfare. Svensson (Amer Econ Rev 96: 448–451, 2006 ) however has disputed this by saying that although feasible, the conditions for which this was true, were not all that likely. In that respect, therefore, increasing ‘transparency’ remains most of the times beneficial to social welfare. In this paper, we extend the Morris and Shin attempt by setting it up as an explicit interactive game between the Central Bank, the objectives of which we model explicitly, and the private sector. We show that in the absence of costs, both players benefit from transparency in the manner described previously in the literature, and point the differences in their gains. Following that, we then introduce the fact that increasing transparency comes at some costs and show how both players face incentives to free ride on each other as a result. The presence of costs thus alters the way in which greater transparency is attained. Copyright Springer Science+Business Media, LLC 2007