We define and study transparency, credibility, and reputation in a model where the central bank's characteristics
are unobservable to the private sector and are inferred from the policy outcome. A low-credibility bank optimally conducts
a more inflationary policy than a high-credibility bank, in the sense that it induces higher inflation, but a less
expansionary policy in the sense that it induces lower inflation and employment than expected. Increased transparency
makes the bank's reputation and credibility more sensitive to its actions. This has a moderating influence on the bank's
policy. Full transparency of the central bank's intentions is generally socially beneficial, but frequently not in the interest of
the bank. Somewhat paradoxically, direct observability of idiosyncratic central bank goals removes the moderating
incentive on the bank and leads to the worst equilibrium.
Full paper (384 KB PDF)
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Last update: July 19, 2001